Idea Cellular

Definition of Globalization

2007-08-01T10:41:00.001-07:00

Question: What's the truest definition of globalization?
Answer: Princess Diana's death.
Question: How come?
Answer:
An English princess with an Egyptian boyfriend crashes in a French tunnel,
driving a German car with a Dutch engine,
driven by a Belgian who was drunk on Scottish whisky,
(check the bottle before you change the spelling)
followed closely by Italian Paparazzl,
on Japanese motorcycles;
treated by an American doctor,
using Brazilian medicines.
This is sent to you by an Englishman,
using Bill Gates' technology,
and you are probably reading this on your computer,
that use Taiwanese chips,
manufactured in a joint venture in China,
and a Korean monitor,
assembled by Bangladeshi workers in a Singapore plant,
transported by Indian lorry-drivers,
hijacked by Indonesians,
unloaded by Sicilian longshoreman,
and trucked to you by Mexican illegals.
That, my friend, is Globalization.

Recognizing a Firm’s Intellectual Assets: Moving Beyond a Firm’s Tangible Resources

2007-05-03T06:51:00.002-07:00

Recognizing a Firm’s Intellectual Assets: Moving Beyond a Firm’s Tangible Resources

2007-05-03T06:51:00.001-07:00

SUMMARY/OBJECTIVES

One of the key trends today is the emergence of the importance of the knowledge worker in today's economy. It is critical for managers to not only recognize the importance of top talent but also the need to leverage human capital in order to innovate and, in the end, to develop products and services that create value.

This chapter is divided into four sections.

1. The first section focuses on the increasing role of knowledge as the primary means of wealth generation in today's economy. After all, in the New Economy a firm's value is based much more on knowledge, know-how, and intellectual assets — not the traditional factors of production (i.e., labor and capital).

2. The second section addresses the key resource itself — human capital — the foundation for the creation of intellectual capital. We explore ways in which the organization can attract, develop, and retain human capital as well as the importance of recognizing the interdependence of these three activities. We also address the value of a diverse work force.

3. Third, we discuss the critical role of social capital, that is, the network of relationships among individuals. We address both social capital within organizations as well as across organizations.

4. The final section focuses on the role of technology in leveraging human capital. This can range from such basic technologies as email to more complex forms such as sophisticated knowledge management systems. We also discuss how technology can play a key role in electronic teams (or e-teams) and enhance the retention of knowledge in an organization.

LECTURE/DISCUSSION OUTLINE

The opening case describes how a licensing and marketing firm, The Wildflower Group, found misfortune by hiring a "star" employee. Although this person was successful in her previous position, she clearly did not "fit" in the new company. She had a bad attitude, strained relationships with fellow employees, and was very disappointed that Wildflower did not have the "comforts and amenities" of a large corporation.

Eventually, things came to a head and she was, in effect, forced to leave the organization. Clearly, she was unable to leverage her talents in order to create value for The Wildflower Group. And, in the process, she destroyed a lot of the firm's social capital!

q Is there any way this situation could have been salvaged, or did the "star" employee have to be terminated?

I. THE CENTRAL ROLE OF KNOWLEDGE IN TODAY'S ECONOMY

We begin by providing some figures on how wealth is increasingly dependent on knowledge-based assets. We use a quotation from Hamel and Prahalad to drive home the importance of knowledge, know-how, and intellectual assets in today's economy. The examples of Microsoft's and Merck's knowledge assets are also given.

To provide some additional "quantitative support" for our arguments, we investigate the tremendous "gaps" between market value and book value — a difference that is considered by many to be an indicator of a firm's "intellectual capital." EXHIBIT 4.1 shows the ratio of market-to-book value for a selected set of companies.

It is useful to pose the following question; it should elicit some interesting responses:

q What are the implications of Exhibit 4.1 for today's organizations?

We then define some of the basic concepts in the chapter:

· Human capital is the "individual capabilities, knowledge, skills, and experience of the company's employees and managers."

· Social capital can be defined as "the network of relationships that individuals have throughout the organization."

· Knowledge comes in two different forms: explicit (easily documented, stored, etc.) and tacit (in the minds of employees and is only shared with their consent).

It is important to point out that the creation of new knowledge involves the continual interaction of explicit and tacit knowledge. We provide the example of engineers working on computer code. This is also a point at which you may wish to address the critical role of socially complex processes (leadership, trust, culture) in leveraging human capital.

The SUPPLEMENT below helps to reinforce the importance of top talent in today's organizations and the need to retain that talent. It raises the concept of "core competents," an insightful contrast to the more commonly known term: core competence.

Winning in the knowledge economy—the importance of core competents

Talented executives will always be in demand and will be able to attract substantial salary and remuneration packages. In effect, corporate power will be concentrated in the hands of the few. "What is critical in the firm of the future is not so much the core competencies as the core competents," predicts Jonas Ridderstrale, a professor at the Stockholm School of Economics. "These walking monopolies will stay as long as the company can offer them something that they want. When that is no longer the case, they will leave."

Ridderstrale points to a growing array of supporting evidence. Bill Gates has reflected that if 20 of Microsoft's key people were to leave, the company would risk bankruptcy. In a study by the Corporate Leadership Council, a computer firm recognized 100 "core competents" out of 16,000 employees; a software company had 10 out of 11,000; and a transportation group deemed 20 of its 33,000 employees as really critical.

Source: Crainer, S. & Dearlove, D. 1999. Death of executive talent. Management Review, July-August: 22.

q What are the implications of these findings for today's organizations?

q What are the career planning implications for you? (that is, how do students see themselves becoming core competents)

II. HUMAN CAPITAL: THE FOUNDATION OF INTELLECTUAL CAPITAL

Organizations must recruit talented people — employees at all levels with the proper set of skills and capabilities coupled with the right values. In this section, we address the hiring/selection, development, and retention processes. EXHIBIT 4.2 illustrates these processes. We suggest the imagery of the three-legged stool.

We provide the rather humorous perspective of Professor Jeffrey Pfeffer (the San Francisco law firm) to illustrate the interdependent nature of these three activities. It may be useful to ask:

q Why do many firms devote more efforts to attracting human capital than they do to developing or retaining talent?

A. ATTRACTING HUMAN CAPITAL

We begin with a quotation from Jack Welch, GE's former acclaimed Chairman and CEO. Then, we question the traditional "lock and key" approach to employee selection and emphasize the importance of employee mindsets, attitudes, and social skills. (It is useful to reemphasize that in today's knowledge economy, the leveraging of human capital is critical — thus, such "soft skills" become more important.)

1. "HIRE FOR ATTITUDE, TRAIN FOR SKILL"

This is a phrase that has become more predominant in today's business environment. This point is driven home with the examples of Southwest Airlines, Rosenbluth International (the travel management company), and Microsoft. It may be interesting to pose the following question:

q Do you think the line of questioning undertaken by Microsoft is a good idea? For Microsoft? For other companies with which you are familiar?

STRATEGY SPOTLIGHT 4.1 discusses the "Bozo filter" that Cooper Software, Inc. uses to screen employees.

q What are the advantages (and disadvantages) of the "Bozo Filter"?

q Would it work in other organizations with which you are familiar?

The SUPPLEMENT below should be very useful to students — it should "personalize" some of the discussion on the development and evaluation of human capital. It summarizes the four qualities that Larry Bossidy (former CEO of Allied Signal) looks for when evaluating job candidates. You might consider asking your students:

q Can these qualities be developed or are they typically inherent in an individual (i.e., a nature/nurture argument)? If so, how can they be developed and nurtured?

KEY LEADERSHIP QUALITIES FOR FUTURE LEADERS: LARRY BOSSIDY

Below are the four key qualities that Larry Bossidy considers when evaluating job candidates:

THE ABILITY TO EXECUTE: Ideas, analytical capacity, and education are important parts of a leader's makeup. However, just as important is being able to implement those ideas. There are people who are fulfilled by expressing big thoughts, but you will be better served by hiring people with boundless energy who can execute the thoughts.

A CAREER RUNWAY: Good leaders have plenty of runway left in their careers. I like to hire someone for this job and also the next job, never for the person's final position. People with perspective on their jobs give me an indication that they have not only the interest but also the ability to go further.

A TEAM ORIENTATION: If someone is able to work through and with other people, he's got better potential then if he is essentially an individual contributor.

MULTIPLE EXPERIENCES: I've learned to consider carefully the dynamics of a candidate's past work experiences. People who come from quasi-monopolistic areas often have great difficulty moving into more competitive environments. You have to understand the environment from which you're hiring; some kinds of companies are better than others at developing leaders. To make sure our future leaders have the right experience, I look for candidates who have operated real Profit & Loss units in two or three different industries or companies. That's how great leaders are grown.

Source: Bossidy, L. 2001. The job of the CEO. Harvard Business Review, 79 (3): 47-49.

2. SOUND RECRUITING APPROACHES AND NETWORKING

We address the exemplary recruiting efforts of Microsoft. Clearly, this firm goes to great lengths to hire the "best and brightest" in their industry.

Teaching tip: The adage "hire for attitude, train for skill" can generate some interesting discussion in the class. Some students may argue that in jobs that require high levels of skill such as software development, skills may be more important than attitude. This may be an opportunity to point out that even in jobs that require high skills and relatively low levels of interdependence with others, poor attitude can lead to lack of effort as well as a lack of willingness to learn, excel, and experiment.

Many companies have found out that their most effective recruiting efforts start closest to home — referrals from their own employees. We provide the example of GE Medical Systems that provides bonuses to employees who refer individuals who are eventually hired.

q What are the advantages of such incentive programs to provide referrals? Are they done at companies with which you are familiar? Should they be implemented?

STRATEGY SPOTLIGHT 4.2 addresses an interesting perspective on the "war for talent." It points out some of the dysfunctional outcomes that can occur when organizations are overly aggressive in attracting talent.

· An invariable emphasis on individual performance (rewarding the individual stars), thereby diminishing teamwork, creating destructive internal competition, and retarding learning and the spread of best practices inside the company.

· A tendency to glorify the talents of those outside the company and downplay the skills and abilities of insiders, leading to a loss of motivation on the part of those inside the firm and to their turnover.

· The creation of a self-fulfilling prophecy where those labeled as less able become less able because they are asked to do less, given fewer resources, training, and mentoring, and become discouraged—in the process ensuring that the organization has way too many people who are in the process of dropping out of the competitive fray.

q Do you agree with this perspective? Why? Why not?

q How can an organization still get "top talent" without falling into such traps?

B. DEVELOPING HUMAN CAPITAL

Organizations must do more than merely hire top-level talent and expect the skills and capabilities of those employees to remain current throughout their employment. Rather, training and development must take place.

We provide examples of Solectron, Motorola, and Cinergy.

The SUPPLEMENT below provides some guidelines/suggestions for enhancing one's career success. Although these points are directed at women managers, they should also apply to men as well. In addition, these issues may spur some lively discussion (such as how much risk one should take, work/life balance, and so on):

THREE SUGGESTIONS FOR ENHANCED CAREER SUCCESS

The following suggestions are drawn from Warren Ferrell, author of Why Men Earn More: The Startling Truth Behind the Pay Gap—and What Women Can Do About It (AMACOM, January 2005).

1. Sign up for a job with bottom-line responsibility

Kathy Vrabeck, president of Activision Publishing, the video-game producer behind Shrek 2 and the Tony Hawk series, believes that this is the advice she could give anyone seeking to earn more money. She had an early glimpse of how this works while at Eli Lilly, when she noticed that R&D was the driving function in pharmaceuticals. At Activision, she's responsible for game development — the function on which the company's success largely depends. According to Vrabeck, "In any company, it's the operating jobs, not the staff jobs that generate revenue. A company's always willing to pay more for people who are willing to take on the responsibility of a line job and the risk it entails."

2. Find a field that entails financial or emotional risk taking

Most venture capitalists can expect to earn between $100,000 and $300,000 a year, according to Salary.com. (Many, of course, earn far more!) Of course, if they bet the farm on an online pet-food supplier, they also risk losing everything. Currency traders, real-estate speculators, and many sales executives all gamble that they can use their drive and smarts to make a good living. If they're right, they can clean up. If not, they have only themselves to blame. The market pays a premium for such chutzpah.

3. Work more hours, more weeks, and more years

Many may declare: "Enough! Americans already work more hours per year than the rest of the planet!" So true. But if you are willing to be the alpha dog of wage slaves in your industry, you can expect to be rewarded handsomely. The U. S. Bureau of Labor Statistics (BLS) reports that the average person working 45 hours per week earns 44% more than someone who works only 40 hours. Why? The willingness to work more often leads to jobs that pay more per hour. At the upper reaches of a corporation, this can be significant. Top CEOs generally command pay in the 7-digit range — but they have also typically paid their dues with 15-hour days, six days a week, for an average of 20 years. The road to higher pay is a toll road with no EZ-Pass for the fast lane!

Source: Tischler, L. 2005. Bridging the (gender wage) gap. Fast Company, January: 85-87.

1. ENCOURAGING WIDESPREAD INVOLVEMENT

The development of human capital requires the active involvement of leaders at all levels. We discuss the broad-based involvement at General Electric. Motorola also is an example where the former Chairman, Robert Galvin, took the initiative in a program to drive home the importance of selected Asian countries.

The SUPPLEMENT below discusses the key role that Roger Enrico, CEO of PepsiCo, plays in developing top talent at his firm.

Developing top talent at Pepsico

In an 18-month period before becoming CEO of PepsiCo, Roger Enrico spent nearly a third of his time at his houses in the Cayman Islands and Montana. This may seem like a pretty unusual way for the vice chairman of a multi-billion company based in Purchase, New York, to perform his job. However, his job is exactly what he was doing. And, he was doing it very well.

In these remote off-site settings, away from the daily demands of making potato chips, selling sodas, and resolving day-to-day problems, Enrico was preparing PepsiCo to survive and thrive in the 21^st Century. He was running his personal "war college" to develop a generation of leaders for PepsiCo. At the end of 18 months, Enrico had prepared 100 leaders as Pepsi's next generation. And, he had fostered some of their best ideas, resulting in an estimated $2 billion in top-line growth.

Source: Tichy, N. 1998. The Leadership Engine. Plano, TX: Pritchett & Associates: 1-2.

2. TRANSFERRING KNOWLEDGE

This brief section addresses some of the challenges associated with transferring knowledge in an organization. It provides the imagery of a "pitcher" and a "catcher" and includes an example of GE Healthcare.

3. MONITORING PROGRESS AND TRACKING DEVELOPMENT

Whether a firm uses on-site formal training, off-site training (e.g., universities) or on-the-job training, tracking individual progress — and sharing this knowledge with both the employee and key managers — becomes essential.

We provide the examples of Citibank, Arthur Andersen, and SmithKline Beecham (now Glaxo SmithKline).

It may be particularly interesting to mention SmithKline's "two-plus-two-plus-two" (two business units, two functional units, and two countries) formula for developing people for top management positions. Ask:

q Should the 2+2+2 approach be used for other large multinational firms? Why? Why not?

4. EVALUATING HUMAN CAPITAL

The primary issue that this section addresses is the 360-degree evaluation system. Such an evaluation approach is becoming more critical given the importance of collaboration and interdependence in today's knowledge intensive organizations. Traditional "top down" evaluation systems evaluate performance from a single perspective and typically do not address the "softer" issues such as social skills, values, beliefs, and attitudes.

EXHIBIT 4.3 provides an excerpt from General Electric's 360-degree evaluation system. We also mention experiences that managers at Warner-Lambert and Saturn (a division of General Motors) have had with this system.

STRATEGY SPOTLIGHT 4.3 summarizes General Electric's "Session C" – an integral part of its leadership evaluation and development process. Ask:

q How does GE's "Session C" compare to other firms' approach to leadership evaluation and development?

The SUPPLEMENT below addresses a few of the pitfalls as well as suggestions for making 360-degree evaluation systems work.

Prior to discussing the supplement, it may be interesting to ask:

q What are some of the pitfalls of 360 degree evaluation systems?

q What steps should be taken to improve the chance of their success when implemented?

Pitfalls and suggestions for making 360 degree systems work

Some of the pitfalls of 360 degree evaluation systems are:

1. If a manager's 360 ratings depend on creating a positive or even relaxed climate, these factors may actually detract from work directly geared toward bottom line results.

2. Organizations may embrace 360 feedback to convey an impression of openness and participation to clients or recruits when, in fact, this is not part of the organization's culture.

3. Imitating without clearly understanding what other firms have accomplished; or the likely outcomes for one's own firm, may be a questionable strategy.

4. Even when 360-degree feedback ratings are used strictly for developmental purposes, individuals will tend to modify behaviors in ways to receive more positive ratings.

Some recommendations on making 360 systems work include:

1. Make consultants/internal champions accountable for results and customization.

2. Engage in a pilot test initiative.

3. Create focus groups to identify effectiveness criteria measures.

4. Evaluate using a pre-post control group design.

5. Be careful what you measure and how it's used.

6. Train raters.

Source: Waldman, D. A., Atwater, L. E., & Antonioni, D. 1998. Has 360 degree feedback gone amok? Academy of Management Executive. 12(2): 86-94.

Teaching Tip: Despite its many advantages, the 360-degree feedback system has some limitations as discussed in the above SUPPLEMENT. Ask the students to think of situations where the application of this tool could lead to dysfunctional consequences and why. Students may come to realize that for the system to work, there has to be better integration between many aspects of the organization such as its culture, leadership, rewards systems, and so on.

C. RETAINING HUMAN CAPITAL

We use the rather colorful imagery of "frogs in a wheelbarrow" to drive home the point that top talent may bolt at any time. Managers have the option of either forcing top talent to stay with the organization via non-compete clauses, golden handcuffs, etc. or providing the type of environment wherein top talent will desire to stay. (We recognize, of course, that employment contracts have their place — but should not be the primary means of the retention of talent.)

It is worthwhile to note that with economic downturns— such as that following the "dot.com crash" beginning in early 2000 — there are needs for massive layoffs in even the most progressive organizations. Consider how Cisco Systems took an innovative approach to employee retrenchment in the SUPPLEMENT below. Ask:

q What are some of the benefits of Cisco's approach to downsizing?

q Should this approach be used in industries where it appears that there will be downsizing for extended periods of time? (Note: It may be helpful to note that there will always be demand for top talent.)

Cisco Systems' innovative approach to downsizing

When Cisco Systems laid off 6,000 full-time employees during the spring of 2001, not all of them were out of a job. In June, the San Jose network provider launched its Community Fellowship Program, matching 80 of these employees with nonprofit organizations for one-year stints. Program participants keep one-third of their base salary, all benefits, and receive new, monthly vested options. At year's end, they'll be considered internal candidates for open positions at Cisco. In return, Cisco gets to hang on to some of its best people.

Source: Ullman, E. 2001. Benevolent downsizing. Working Women. September: 18.

1. IDENTIFYING WITH AN ORGANIZATION'S MISSION AND VALUES

People who identify with and are more committed to the core mission and values of the organization are less likely to stray or bolt to the competition. We provide the example of Medtronic and their motto: "Restoring patients to full line," which helps to reinforce a stronger identity of its employees with the firm.

We also mention the importance of "strategic intents" and give examples of such firms as Komatsu, Cannon, and Richard Branson's Virgin Group.

q What are other examples of firms that have successfully strengthened an employee's identification with their firm's mission and values?

The SUPPLEMENT below provides an example of a biotechnology company where the CEO fosters a culture that is based on the passion he has for the firm's mission — curing diseases.

HOW GENZYME'S CEO STIRS EMPLOYEES' PASSION FOR THEIR WORK

Henri Termeer, CEO of Genzyme, a biotechnology firm based in Cambridge, Massachusetts, regularly meets with people who suffer from the diseases on which his researchers are working. He wants to feel angry about the pain and loss the disease is casing and passionate about the need to find cures. Further, he wants to transmit that passion to those working at his firm. Equally important, he backs his words with actions. Since the company focuses on therapies for rare diseases, the cost of treatment is high. However, Genzyme refuses to let economics get in the way of its commitment to treat the afflicted. The firm literally searches them out in Third World countries for free treatment. By acting on the firm's beliefs, Termeer stirs the passion and engages the energy of Genzyme's employees.

Source: Bartlett, C. A. & Ghoshal, S. 2002. Building competitive advantage through people. MIT Sloan Management Review, Winter: 34-41.

2. CHALLENGING WORK AND A STIMULATING ENVIRONMENT

The motivation to work on something because it is interesting, exciting, or personally challenging underlies the importance of intrinsic motivation. We provide quotations from executives from both Gillette and Intuit.

In addition, some leading-edge firms have kept highly mobile employees motivated and challenged by lowering the barriers to an employee's mobility within a company. For example, Shell Oil Company has recently created an "open sourcing model" for talent.

3. FINANCIAL AND NON-FINANCIAL REWARDS AND INCENTIVES

Clearly, financial rewards are a vital organizational control mechanism (as we will also discuss later in Chapter 9). We refer to an article in Organizational Dynamics to discuss the limitations of money as the most important factor in attracting and retaining human capital. After all, top talent is a highly mobile asset, and such individuals are likely to always be able to attract competing offers — even in relatively tight labor markets.

The SUPPLEMENT below addresses an insightful perspective on the downsides of stock options as a retention vehicle for top talent. Before discussing, you may wish to ask:

q What are the advantages and disadvantages of using stock options to retain talent?

Some of the "downsides" of stock options as a retention device

Employee ownership is a great thing — it helps employees to think like owners. But options are not the same as ownership. In real employee stock ownership, employees purchase shares and thus have, to use the colloquial phrase, "skin in the game." They are committed.

On the other hand, options are given to employees, not purchased. When the stock price goes down, the options are repriced or, now that repricing has become less acceptable to institutional investors, companies issue more options at the lower price, as Microsoft and Amazon.com have done. The potential dilution to earnings is enormous, even if accounting conventions do not yet fully capture the hit.

Additionally, as technology and venture capitalist William Gurley has observed, options encourage a gambling mentality. Go for broke. If there's a win, fine. If there's disaster, move on and try again. That is not the mentality of real ownership.

Source: Pfeffer, J. 2001. What's wrong with management practices in the Silicon Valley? A lot. MIT Sloan Management Review, 42 (3): 102.

We close this section with examples of what firms are doing to increase retention through the offering of amenities and flexibilities. We provide an example of USAA, the San Antonio-based insurance and financial services company.

STRATEGY SPOTLIGHT 4.4 addresses how Dow Chemical evaluates its success in retaining promising managers.

ENHANCING HUMAN CAPITAL: THE ROLE OF DIVERSITY IN THE WORKFORCE

This section addresses diversity in today's workforce today which has become more vital due to demographic trends and the accelerating globalization of business. We address some of the emerging demographic trends which have created a more diverse society.

We then address six areas in which a diverse workforce can improve an organization's effectiveness. The first two of these are what might be considered "inevitability-of-diversity" and the last four are considered "value-in-diversity." These are:

1. Cost Argument

2. Resource Acquisition Argument

3. Marketing Argument

4. Creativity Argument

5. Problem-Solving Argument

6. System Flexibility Argument

STRATEGY SPOTLIGHT 4.5 discusses a firm with a well-recognized exemplary diversity program — Enterprise Rent-a-Car.

Ask:

* Are you aware of organizations that have exemplary (or ineffective) diversity programs? If so, what makes them successful (or unsuccessful)?

The SUPPLEMENT below addresses the value of diversity in nationalities and cultures when performing creative activities. But, there it also mentions that people must be on the "same page philosophically" to avoid dysfunctional outcomes and attain integration. One of the basic tenets of organization becomes appropriate, that is the requirement for more differentiation (of ideas) necessitates more integration.

THE VALUE OF DIVERSITY IN CREATIVE ACTIVITIES

Leading a high-performing group begins with hiring the right people. If creativity is all about seeing things differently, claims Bob Brunner, a partner at the San Francisco office of the design studio Pentagram (projects have included the stowaway keyboard for PDAs (personal digital assistants) and Callaway's golf-ball packaging), then assembling a group of people who have a mix of nationalities and culture can spark ideas and generate energy. But Brunner contends that "polyglot ferment can turn toxic" if workers aren't on the same page philosophically. "In hiring, it's important to learn what they really believe about design and what drives their work," he says. "Make sure it's in alignment with where you want to go."

Source: Tischler, L. The care and feeding of the creative class. Fast Company. December: 93-95.

III. THE VITAL ROLE OF SOCIAL CAPITAL

Successful firms are well aware that the attraction, development, and retention of talent is a necessary but not sufficient condition for creating competitive advantages. In the knowledge economy, it is not the stock of resources that is important, but rather the extent to which it is combined and leveraged. Thus, the development of "social capital" — friendships and working relationships among talented individuals, helps to tie knowledge workers to a given firm.

We provide the hypothetical example of two Nobel Prize winning scientists. The point, of course, is that the situation in which there are strong ties among the professionals is the one in which retention is more likely to occur.

Another way to view these perspectives is drawn from the resource-based view of the firm. Here, competitive advantages that are harder for competitors to duplicate are those that are based on "unique bundles" of resources — which occurs when individuals are actively collaborating and sharing knowledge.

STRATEGY SPOTLIGHT 4.6 addresses how Nucor, a highly successful steel manufacturer, develops social capital among its employees and manages.

q Would such approaches work at organizations with which you are familiar? Why? Why not? (For example, a particular type of culture may be too entrenched.)

1. HOW SOCIAL CAPITAL HELPS TO ATTRACT AND RETAIN TALENT

The importance of social ties among talented professionals is creating an important challenge (and opportunity) for organizations today. The phrase: "Pied Piper Effect" has been coined to depict the phenomena in which teams or networks of people are leaving one company for another. Thus, a trend is evolving to recruit job candidates at the crux of social networks in organizations, particularly if they are seen as having the potential to bring with them a raft of colleagues.

We provide the example of an electronic commerce company called Third Millennium Communications. Additionally, EXHIBIT 4.4 provides a partial listing of companies that have been formed by groups of former Microsoft employees.

STRATEGY SPOTLIGHT 4.7 discusses the tremendous benefit that Cooley Godward, a law firm, obtained by keeping a positive relationship with one of its lawyers who left the firm. The example stresses the importance of "alumni clubs" for former employees. Ask:

q Would such a program be useful in organizations with which you are familiar?

2. THE POTENTIAL DOWNSIDE OF SOCIAL CAPITAL

To provide balance to the discussion, it is useful to address some of the downsides of social capital. There are primarily two issues:

First, when people identify strongly with a group they sometimes support ideas that are suboptimal or simply wrong. If there are strong social pressures (such as "groupthink"), people may be hesitant to challenge each other with touch questioning. This prevents them from engaging in "creative abrasion" — a termed coined by Harvard's Dorothy Leonard-Barton — a key means to innovative activity.

Second, the socialization process whereby individuals are socialized in the norms and values of an organization can be potentially expensive — both in terms of financial resources and managerial commitment. Such expenses should be evaluated in terms of anticipated benefits.

IV. USING TECHNOLOGY TO LEVERAGE HUMAN CAPITAL AND KNOWLEDGE

Here, we discuss how technology can be used to leverage human capital and knowledge in organizations as well as beyond their boundaries to include customers and suppliers. We will address both simple and more complex applications of technology as well as how technology can help firms to retain employee's knowledge — even when they terminate their employment.

A. USING NETWORKS TO SHARE INFORMATION

Clearly, e-mail is a very effective means of communicating a wide range of information. It is quick, easy, and almost costless. It can, of course, become a problem if it is used inappropriately (as with the Computer Associates example), but it has its benefits. We provide the perspective of Martin Sorrell, Chairman of the WPP Group, the huge advertising and public relations firm.

Teaching Tip: Clearly, e-mail can be a double-edged sword. In the chapter we talk of its productivity-enhancing properties. Ask the students how e-mail can end up consuming organizational resources and erode productivity. Further, ask them for suggestions on how an organization can cope with some of these negative aspects and realize the positive potential of e-mail.

We also address how technology can play a key role in helping a firm develop a knowledge sharing network. We provide an example of Buckman Laboratories, a $300 million specialty chemicals company. Ask:

q What must Buckman do, other than implementing technology, to make this network effective? (Hint: Mention reward systems, evaluation systems, effective culture, etc.)

B. ELECTRONIC TEAMS: USING TECHNOLOGY TO ENHANCE COLLABORATION

Technology has also enabled professionals to work as part of virtual teams to enhance the speed and effectiveness with which products and services are developed. For example, it helps to accelerate the design and testing of new software modules that use the Windows-based framework as a central architecture.

We discuss the two main ways in which electronic teams are different from traditional teams (geographical separation of team members; communication by electronic communication channels such as faxes, e-mail, etc.).

The two key challenges of making e-teams effective include: members must identify with who among them can provide knowledge and resources; and leaders must be able to know how to combine individual contributions.

We then summarize the key findings in a study conducted by Sabre, the large computerized reservation system. Based on 65 teams, the key attributes of successful e-teams were:

· Develop trust based on performance consistency rather than social bonds.

· Overcome group process losses associated with virtual teams

· Create an environment of inclusiveness and involvement

· Identify with members with a proper balance of technical and interpersonal skills

· Create proper mechanisms for evaluating team members and providing coaching and support

Ask:

q Have you participated in electronic teams? Have they been successful? Have they conformed to the above five attributes? What other attributes have they had? Did those attributes add to or detract from performance?

C. CODIFYING KNOWLEDGE FOR COMPETITIVE ADVANTAGE

There are two different types of knowledge: tacit (embedded in personal experience) and codified (knowledge that can be documented, widely distributed, and easily replicated). A challenge of knowledge-intensive organizations is to capture and codify the knowledge and experience that, in effect, resides in the heads of their employees.

We provide the example of Accenture (formerly Andersen Consulting), which has successfully codified the knowledge of its consultants by storing it in electronic depositories. Thus, the knowledge can be employed in many jobs by a large number of consultants since there are strong similarities across assignments.

For such a system to work, training becomes very important. Using the knowledge management depository, newly hired Accenture consultants work through many scenarios designed to improve business processes.

The SUPPLEMENT below provides some more detailed information on Accenture's knowledge management systems.

Accenture's knowledge management systems

Accenture strives to electronically interlink more than 82,000 people in 360 offices in 76 countries. Its ANET, a T-1 and frame relay network, connects 85 percent of Accenture's people through data, voice, and video interlinks. ANET permits specialists — by posting problems on electronic bulletin boards and following up with visual and data contacts — to instantly self-organize around a customer's problem anywhere in the world. It thus taps into otherwise dormant capabilities, and vastly expands the energies and solution sets available to customers. The capacity to share in the enormous variety of problems and solutions is enhanced through centrally collected and carefully-indexed subject, customer, and resource files accessible directly via ANET or from CD-ROMs, distributed to all offices. These, in turn, expand the intellectual capabilities field personnel have available to add value for future customers.

Soruce: Quinn, J. B., Anderson, P. & Finkelstein, S. 1996. Leveraging intellect. Academy of Management Executive, 10 (3): 9.

q Are there knowledge management systems with which you are familiar? Are they effective? Why? Why not?

We then discuss the knowledge management system used by Access Health, a call-in medical center. Although it was very expensive to develop, the company's paying customers — insurance companies and provider groups — save money because many callers would have made expensive trips to the emergency room or the doctor's office had they not been diagnosed over the telephone.

STRATEGY SPOTLIGHT 4.8 addresses how Dell Computer's sophisticated knowledge management system is an integral part of its widely admired business model.

The SUPPLEMENT below provides some guidelines on making knowledge management systems effective. Prior to discussing the supplement, you may pose the following question:

q What are some guidelines on making knowledge management systems effective? (It will be interesting to see what issues are brought up and how they compare and contrast with the supplement)

Making knowledge management systems effective

Persuading people to empty their brains into a knowledge management system isn't easy. Fortune magazine asked some experts how to make it effective. Here are some of their perspectives:

1. Create heroes: Build a system that rewards those who share knowledge.

2. Follow through: Hire someone to manage and update the system.

3. Don't let it be in vain: Make sure employees get something out of it.

4. Bring in the boss: Involve upper management to emphasize the system's importance.

5. Make it a no-brainer: Design a tool that is easy to use.

6. Focus on culture: Foster an environment where sharing information is in vogue.

Source: Koudsi, S. 2001. Actually, it is like brain surgery. Fortune, March 20: 234.

NOTE: These issues and others are addressed in the next section with the example of the IAN system at Context Integration.

The SUPPLEMENT below builds on STRATEGY SPOTLIGHT 4.6 (Nucor) and explains how Nucor also shares best practices to help build new steel mills: (This example helps to point out that knowledge can be shared with a minimum of IT — information technology. It also points out that knowledge sharing practices can be very useful when involving engineers and production workers at the plant level.)

HOW NUCOR USES BEST PRACTICES TO IMPROVE START-UP PLANTS

Nucor systematically recycles process innovations from existing plants to new plants. The firm builds or rebuilds one or more mills each year. Rather than rely on outside contractors to build the plant, Nucor assembles a team of engineers from existing mills. This internal group is responsible for designing and managing the construction of any new building or rebuilding project. Furthermore, Nucor hired local workers to construct mills and informed them that they were likely to be recruited later to operate the mills.

Nucor's unique approach has yielded several benefits. First, existing process knowledge was recycled into new-plant design and construction. Second, construction workers knew that they were building the plant for themselves and had a clear incentive to build it well. Third, knowledge of the underlying process technology embedded in the plant design was transferred over in the workers' minds from the construction phase to the operations phase. Fourth, plant start-up expertise emerged as yet another of Nucor's core competencies.

Source: Gupta, A. K. & Govindarajan, V. 2000. Knowledge management's social dimension: Lessons from Nucor Steel. MIT Sloan Management Review, 42 (1): 71-80.

The SUPPLEMENT below discusses how Sharp Electronics was able to develop effective knowledge-management software for its front-line sales representatives. The key: the reps built the system from scratch and involvement was a key part of their reward system.

SHARP ELECTRONICS' SUCCESSFUL KNOWLEDGE MANAGEMENT SYSTEM

Knowledge management software, which helps call centers deliver consistent answers to customers' questions are typically not very effective. Why? Representatives have to take time out from answering calls to input things they have learned, i.e., putting the "knowledge" in knowledge management. According to Brad Cleveland, who heads the Incoming calls Management Institute: "The software is just a tool. It doesn't do any good unless people across the organization are using it to its full potential."

Sharp Electronics, however, has made theirs work. Sharp's frontline reps built the system from scratch. Also, as Sharp rolled out its network over the past four years, reps' compensation and promotions were tied to its use. As a result, the customer call experience has improved dramatically. Now, the proportion of problems resolved by a single call has increased from 76% to 94% since 2000.

Source: McGregor, J. 2004. Putting customers first. Fast Company. October: 87.

D. RETAINING KNOWLEDGE WHEN EMPLOYEES LEAVE

Turnover, even in the best organizations, is an organizational fact of life. However, many leading-edge firms are devising ways of minimizing the loss of knowledge when employees leave.

Customer relationship management software, for example, automates and provides salespeople access to client histories and groupware applications such as Lotus Notes can standardize interactions and keep records of decisions and crucial contextual information. Also, even simple technologies such as email can help when employees leave an organization. We provide the example of a project manager at Young & Rubicam, a large international advertising firm.

Providing motivation and incentives are also important in making knowledge management systems work. We provide the example of the Intellectual Assets Network (IAN) that was developed at Context Integration, a Web consulting firm.

q What do you see as the potential benefits of this network? The downsides?

The SUPPLEMENT points out that employees can be a valuable source of ideas — even after they leave the firm. It is a rather interesting example because the term "don't burn bridges" is usually applied to employees. However, it can also apply to employers!

HOW DEPARTED EMPLOYEES CAN ADD VALUE TO A FIRM

Despite a period of relentless downsizing in the petroleum industry in recent years, the petroleum industry has recognized the value of its knowledge workers. Typically, firms have treated them honorably, with generous severance packages and encouragement to maintain at least a social relationship with their former employees.

As a result, a whole ecosystem of highly specialized boutique consulting shops has evolved which cater to the industry's specialized technology needs. These shops are often composed of departed employees from a single oil and gas company, with whom they loyally conduct the bulk of their business. For example, Geomechanics International (GMI), founded by Colleen Barton of Stanford, augmented its expertise with the best of Mobil's drilling engineering and geoscience personnel, who departed at the time of the Exxon Mobil merger.

Mobil now uses GMI's technology to minimize rock stress damage to its high-case wells-technology that would not be available without these workers. Similarly, David Lumley of Chevron led his team of 4D imaging experts out the door to found 4^th Wave, Inc. The new firm endeavors to develop methods for Chevron (and others) to monitor the real-time movement of hydrocarbons in reservoirs, a potential breakthrough in squeezing several hundred million more barrels of oil out of a large producing field.

Source: Rajagopalan, B., Peterson, R. & Watson, S. B. 2003. The rise of free agency: Is it inevitable? Organizational Dynamics, 32 (1): 99.

q Do you know of some employees who lost their jobs at a firm but were later hired back as consultants? Did it work out well? Why? Why not?

EXHIBIT 4.5 provides a series of questions that managers should consider in determining (1) how effective their organization is in attracting, developing, and retaining human capital, and (2) how effective they are in leveraging human capital through social capital and technology.

V. THE CENTRAL ROLE OF LEVERAGING HUMAN CAPITAL IN STRATEGY FORMULATION

In this chapter, we have emphasized the importance of human capital and how such intangible assets can create the greatest value in today's successful organizations. As we have noted throughout the chapter, attracting top talent is a necessary but not sufficient condition for competitive advantage. It must not only be developed and retained, but also leveraged through the effective use of social capital and technology.

In this section, we briefly address the relevance of leveraging human capital in the process of strategy formulation — for the next four chapters of the book (Chapters 5-8).

A. LEVERAGING HUMAN CAPITAL AND BUSINESS-LEVEL STRATEGY (CHAPTER 5)

B. LEVERAGING HUMAN CAPITAL AND CORPORATE-LEVEL STRATEGY (CHAPTER 6)

C. LEVERAGING HUMAN CAPITAL AND INTERNATIONAL STRATEGY (CHAPTER 7)

D. LEVERAGING HUMAN CAPITAL AND INTERNET STRATEGIES (CHAPTER 8)

VI. SUMMARY

Firms throughout the industrial world are recognizing that the knowledge worker is the key to success in the marketplace. However, we also recognize that human capital, although vital, is still only a necessary but not sufficient condition for creating value. We began the first section of the chapter by addressing the importance of human capital and how it can be attracted, developed, and retained. Then we discussed the role of social capital and technology in leveraging human capital for competitive success. We pointed out that intellectual capital — the difference between a firm's market share and its book value — has increased significantly over the past few decades. This is particularly true for firms in knowledge-intensive industries, especially where there are relatively few tangible assets such as software development.

The second section of the chapter addressed the attraction, development, and retention of human capital. We viewed these three activities as a "three legged stool." That is, it is difficult for firms to be successful if they ignore or are unsuccessful in any one of these activities. Among the issues we discussed in attracting human capital were "hiring for attitude, training for skill" and the value of using social networks to attract human capital. In particular, it is important to attract employees who can collaborate with others given the importance of collective efforts such as teams and task forces. With regard to developing human capital, we discussed the need to encourage widespread involvement throughout the organization, monitor progress and track the development of human capital, and evaluate human capital. Among the issues that are widely practiced in evaluating human capital is the 360-degree evaluation system. Employees are evaluated by their superiors, peers, direct reports, and even internal and external customers. Finally, some mechanisms for retaining human capital are employees' identification with the organization's mission and values, providing challenging work and a stimulating environment, the importance of financial and nonfinancial rewards and incentives, and providing flexibility and amenities. A key issue here is that a firm should not overemphasize financial rewards. After all, if individuals join an organization for money, they also are likely to leave for money. With money as the primary motivator, there is little chance that employees will develop firm-specific ties to keep them with the organization. We also address the value of a diverse workforce.

The third section of the chapter discussed the importance of social capital in leveraging human capital. Social capital refers to the network of relationships that individuals have throughout the organization as well as with customers and suppliers. Such ties can be critical in obtaining both information and resources. With regard to recruiting, for example, we saw how some firms are able to hire groups of individuals en masse who are part of social networks. Social relationships can also be very important in the effective functioning of groups. Finally, we discussed some of the potential downsides of social capital. These include the expenses that firms may bear when promoting social and working relationships among individuals as well as the potential for "groupthink", wherein individuals are reluctant to express divergent (or opposing) views on an issue because of social pressures to conform.

The fourth section addressed the role of technology in leveraging human capital. We discussed relatively simple means of using technology such as e-mail and networks where individuals can collaborate by way of personal computers. We also addressed more sophisticated uses of technology such as sophisticated management systems. Here knowledge can be codified and reused at very low cost, as we provided in the examples of firms in the consulting, health care, and high technology industries. We discuss how electronic teams can be effectively used. Also, given that there will still be some turnover — voluntary or involuntary — even in the most desirable places to work, technology can be a valuable means of retaining knowledge when individuals terminate their employment with a firm.

The final section addressed how the leveraging of human capital is critical in strategy formulation at all levels. This includes the business, corporate, international, and Internet levels.

PowerPoint:Assessing the Internal Environment of the Firm

2007-05-03T06:45:00.001-07:00

Assessing the Internal Environment of the Firm

2007-05-03T06:43:00.001-07:00

SUMMARY/OBJECTIVES

The purpose of this chapter is to help students understand the importance of the internal environment of the firm. Chapter 2 focused on assessing the external environment; we turn our attention in this chapter to managing value creating activities within the company.

Introduce the chapter by reminding students of the limitations of SWOT analysis mentioned in Chapter 2. SWOT analysis was suggested as a starting point for analysis, but not an ending destination. This chapter adds value chain analysis, the resource based view of the firm, and the balanced scorecard as methods for analyzing the firm's internal environment. The chapter is organized into three sections.

1. Value Chain Analysis: The firm's activities are divided into a series of value-creating steps. Both individual activities as well as the interrelationships among activities within the firm—and between the firm and its suppliers, customers, and alliance partners--add value to the firm.

2. Resource based view of the firm: We analyze the firm as a collection of tangible and intangible resources and organizational capabilities. The key to the sustainability of advantages is the creation of bundles of activities that satisfy four criteria: rare, valuable, difficult to imitate, and difficult to substitute. We also discuss how value can be appropriated by an organization's stakeholders, such as employees.

3. Two approaches to evaluating firm performance: We emphasize both the inclusion of the analysis of financial resources as well as the interests of multiple stakeholders. Central to our discussion is Kaplan and Norton's concepts of the "balanced scorecard," and the "strategy map."

LECTURE/DISCUSSION OUTLINE

The introductory case is Jaguar, a unit of Ford Motor Company that has been a significant drain on the corporation's earnings. Although Jaguar has improved its efficiency and overall product quality in recent years, its marketing, engineering, and styling have been flawed.

q What are the underlying causes of this problem (e.g., pressure to lower costs, increase unit sales volumes, leverage Jaguar brand)?

q What should be done?

The SUPPLEMENT below provides a brief update on Ford's recent financial performance. Although the firm is profitable overall, its automotive operations continue to be a drag on corporate performance. Further restructuring to reduce costs is in the near future.

FORD'S ONGOING PROBLEMS WITH ITS AUTOMOTIVE OPERATIONS

Although Ford is profitable overall (with pretax earnings of $2.7 billion through late 2005), these profits are coming from its financial services sector. Ford's automotive operations in North America are suffering losses — amid a vicious price war, high plant and labor costs, and falling market share. In the second quarter of 2005, Ford lost $907 million on North American automotive operations (General Motors's corresponding loss was $1.2 billion.)

In early 2005, Chairman Bill Ford abandoned his goal of generating $7 billion in pretax income by 2006, and in July the company stopped providing quarterly earnings guidance to Wall Street. Ford's stock has slid 37% between the beginning of 2004 and late-2005. And, in May 2005, its bonds earned a junk rating from Standard and Poor's.

Ford will need to make some drastic changes to make its factories profitable. The planned restructuring will include several plant closings and job cuts in the 10,000 range. (Current American employment in late-2005: 123,000)

Source: Muller, J. 2005. Tough repair job. Forbes. September 5: 48-50.

Prior to moving on to value chain analysis, discuss STRATEGY SPOTLIGHT 3.1. It highlights the advantages and limitations of SWOT analysis. We revisit the failed firm – ProCD (from Chapter 2) that entered the electronic telephone directory business with high hopes. This is a useful example to further reinforce the need to "go beyond" SWOT analysis and the need for value chain analysis in analyzing the internal environment of the firm.

I. VALUE CHAIN ANALYSIS

Value chain analysis views the organization as a sequential process of value-creating activities. Such an approach is very useful for understanding the building blocks of competitive advantage. In competitive terms, value is the amount that buyers are willing to pay for what a firm provides for them. And, a firm is profitable to the extent that the value that it receives exceeds the total costs involved in creating the product or service.

Value chain analysis is described in Michael Porter's seminal book, Competitive Advantage. EXHIBIT 3.1 illustrates Porter's value chain — which consists of both primary and support activities.

q What changes in the value chain would be necessary if the CEO of a manufacturing firm decided to dramatically improve the delivery time of his or her products?

q What are some examples of organizations that perform "very well" or "very poorly" with respect to the items in this exhibit?

Point out that when using value chain analysis one needs to view the concept in its broadest context, i.e., without regard to the boundaries of a given organization. That is, include suppliers, customers, and alliance partners.

The balance of this section will address primary activities, support activities, and the importance of relationships among activities — both inside and outside the boundaries of a firm.

A. PRIMARY ACTIVITIES

There are five categories of primary activities in an organization that is competing within any industry. These are included in EXHIBIT 3.2 — along with examples of each activity.

q What are some examples of firms with which you are familiar that are successful (or unsuccessful) in each of the primary activities? Why?

Now, we will address each of the five primary activities.

1. INBOUND LOGISTICS

Inbound logistics are associated with the receiving, storing, and distributing of inputs to the product. It includes material handling, warehousing, inventory control, vehicle scheduling, and returns to suppliers.

We provide the example of Toyota's exemplary use of JIT inventory systems — in which parts deliveries arrive at its assembly plants only hours before they are used.

q How does this JIT system help Toyota to enhance its competitive advantages?

The SUPPLEMENT below illustrates how Weyerhaeuser was able to enhance its competitive advantages by improving its customers' inbound logistics.

Enhancing your customers' inbound logistics activities

Weyerhaeuser employees at a sawmill in Cottage Grove, Oregon began spending a week at a time with their customers to decide how to improve their operations. They were there to look, listen, and learn — not to sell. They were able to bring back insights that enabled them to distinguish their mill. For example, they began to wrap their lumber in plastic and paint the ends in a distinctive color. They learned to load the lumber onto railway cars in a way that made it easier to unload. Buyers soon found that they were dealing with the field and telephone sales personnel who not only understood their problems but also frequently anticipated them. In the customers' minds, Weyerhaeuser's lumber became different from any other. In essence, it became a branded item in an ocean of undifferentiated offerings.

Source: Gouillart, F. J. & Sturdivant, F. D. 1994. Spend a day in the life of your customers. Harvard Business Review, 72(1): 125.

q What other companies are you aware of that also interact this closely with their customers?

2. OPERATIONS

Operations include all activities associated with transforming the final product form, such as machining, assembly, equipment, testing, printing, and facility operations.

We discuss how Shaw Industries, the world's largest carpet manufacturer, became known for its strong concern about the natural environment. They have received numerous awards for their recycling efforts.

STRATEGY SPOTLIGHT 3.2 discusses how Canon improved its operations by applying the principles of the Toyota Production System. Ask:

q Why do you think the cell production system worked at Canon? (e.g., production workers had responsibility for a finished product – not just a single function.)

The SUPPLEMENT below addresses how Southwest Airlines is able to maintain superb productivity in an intensely competitive industry. This example may be particularly interesting because most of the attention at this firm is directed at its culture and colorful Chairman, Herb Kelleher.

Ensuring high productivity at Southwest Airlines

The key to our low costs is high productivity. We consistently demonstrate the highest asset utilization of any U.S. airline. Because we schedule point-to-point for local passengers, not connections, we minimize the amount of time the aircraft is at the gate, less than 25 minutes. This results in higher aircraft and airport utilization and, therefore, fewer aircraft and airport facilities than we would need otherwise. And, it allows our employees to be more productive.

One aircraft type, the Boeing 737, is operated by Southwest. This significantly simplifies our operation, in terms of scheduling, staffing, training, and maintenance. And it certainly contributes to lower costs. As the launch customer for Boeing on its–300, -500, and, most recently, -700 models, we enjoy attractive acquisition costs. This, coupled with our young, well-maintained fleet, allows us to achieve low costs of ownership.

Source: 1999 Southwest Airlines Annual Report: 10.

q What are some other ways that Southwest Airlines is able to lower costs? (It may be interesting to see how many students are aware of these: 70 percent of tickets are sold directly versus 10-15 percent average in the industry — lowering travel agent commissions; ticketless travel reduces significant paper and back office expenses; reusable boarding passes — and no assigned seating, etc.)

q What are some of the advantages to being the low cost competitor in this industry? (e.g, higher margins, remaining profitable in downturns, reduce/eliminate the need for layoffs, etc.)

3. OUTBOUND LOGISTICS

The activities of outbound logistics are associated with the collecting, storing, and distributing the product or service to buyers. They include finished goods warehousing, material handling, delivery vehicle operations, order processing, and scheduling.

Our example is the use of electronic data interchange (EDI) for Campbell Soup, whereby Campbell has forged close links with their customers to both forecast future demand as well as determine what products require replenishment.

q How does the use of EDI help Campbell Soup to enhance their competitive advantages in the marketplace? (Drawing on our discussion from Chapter 2, mention that it also increases their customers' switching costs.)

4. MARKETING AND SALES

Marketing and sales activities are associated with purchases of products and services by end users and the inducements to get them to make purchases. They include advertising, promotion, sales force, quoting, channel selection, channel relations, and pricing.

We provide the example of Monsanto's effective efforts to convince channel partners to purchase their line of KeepSafe^® (previously Saflex^®) windows. It was critical to coordinate the product's value propositions.

The SUPPLEMENT below addresses the importance of advertising for trade associations to get their members' message across to the public.

THE LOW-CARBOHYDRATE ATKINS DIET HAS FORCED SOME TRADE ASSOCIATIONS
TO DO SOME HEAVY ADVERTISING

The low-carb Atkins Diet has become so popular in Britain that producers of starchy foods are worried. Although bread sales are down just 2 percent over the past three years, the food industry isn't taking it easy.

In September 2003, the British Potato Council, the Federation of Bakers, and the Flour Advisory Bureau held a "Carbo Summit" to unveil a study — funded by the industry — highlighting the health risks of low-carbohydrate diets. The Potato Council is spending $1.6 million on marketing, including a bus tour traveling the country passing out potatoes. In October, (also known as British Bread Month), the Federation of Bakers used retail promotions to try to boost bread's image as low-fat. "People think of bread and potatoes as fattening," say Tamara de Grassi, a nutritionist at the Flour Advisory Bureau. "But carbohydrates provide important nutrients." Atkins officials say their diet allows "realistic" portions of starches.

While the carb crowd is hurting, the meat producers are living high on the hog. The U.K. Meat and Livestock Commission reports that consumption rose to a record 4.3 million tons in 2002 — up from 4.2 million the previous year.

Source: Cohn, L. 2003. Starch is on the march. BusinessWeek, September 8: 10.

The SUPPLEMENT below discusses a very important aspect of marketing — marketing research. The example is Coach, a high-end producer of leather handbags and other leather products. (It should be of particular interests to marketing majors.)

COACH: USING EFFECTIVE MARKETING RESEARCH

Coach, with $1.4 billion in revenues, has put its leather in Lexus cars and Coach insignia on Canon Elph digital camera cases. However, the firm has turned down offers to lend its name to hotels or athletic drinks. It calls the strategy "focus" — and the Frankfort, Germany-based firm admits it had a rather stodgy image a decade ago. How things have changed! In its category, Coach ranks first for average annual total return (73.3%) since its October 2000 public offering, as well as first for average sales growth (21%), and earnings-per-share growth (60.1%) over the past five years.

Coach clearly knows its customers' buying habits. It spends $4 million to $5 million a year on market research, including talking to 15,000 women on the phone, in-store or via the Internet or regular mail. From that, Coach knows the biggest spenders visit the stores every four to five weeks. With this information — Coach rolls out its new products and store designs to keep pace with this "rhythm." Last year, for example Coach introduced Madison, a satin and rhinestone line of evening bags that cost 20% or so more than its average $229 bag — it already makes up 5% of store sales.

Source: Fass, A. 2005. Thank you for spending $300. Forbes, January 10: 150.

5. SERVICE

This includes all activities associated with providing service to enhance the value of products such as installation, repair, training, parts supply, and product adjustment.

We discuss the importance of service for Internet-based retailers (e-tailers). In particular, we discuss the exemplar examples of Sephora.com and a more established, traditional retailer, Nordstrom's.

STRATEGY SPOTLIGHT 3.3 discusses one of Richard Branson's innovative approaches to exemplary customer service at Virgin Atlantic – the use of amphibious vehicles (Gibbs Aquada) to ferry first-class passengers down the Thames River to London's Heathrow International Airport.

q What has your experience been with customer service when patronizing Internet firms? How can/should it be improved?

B. SUPPORT ACTIVITIES

Support activities in the value chain are involved with competing in any industry and can be divided into four generic categories, as shown in EXHIBIT 3.3.

q What firms are you familiar with that excel in some of the items included in Exhibit 3.3? How does such excellence enhance their competitive position in their industry? How hard would it be for competitors to copy?

We will now discuss each of the four support activities.

1. PROCUREMENT

Procurement refers to the function of purchasing inputs used in a firm's value chain, not the purchased inputs themselves. Purchased inputs include raw materials, supplies, and other consumable items as well as such assets as machinery, laboratory equipment, office buildings, and buildings.

We discuss the example of how Microsoft improved their procurement operations by providing formal reviews of its suppliers. The example points out the value of constructive feedback and evaluation.

q What are some of the benefits of such evaluation for both Microsoft and its suppliers?

The SUPPLEMENT below discusses how RoweCom, an electronic subscription agent on the Internet, has been successful by enhancing the procurement operations of its customers — libraries.

How RoweCom succeeds by helping libraries save money

Publishers traditionally have sold periodicals to libraries through subscription agents. Agents typically consolidate orders from many libraries and forward them to publishers, charging 3 % to 5 % of the list price for their services. RoweCom permits libraries to order periodicals directly from publishers over the Internet and make payments electronically through Bank One. RoweCom also provides a new level of service. For instance, libraries can easily use the site to track their budgets. Most important, however, RoweCom charges $5 per transaction, not the 3 % to 5 % of the list price. As a result, libraries have been moving their expensive orders to RoweCom. In a recent 18-month period, more than 75 libraries—including some of the largest in the nation have subscribed to RoweCom's Internet service.

Source: Ghosh, S. 1998. Making business sense of the Internet. Harvard Business Review, 76 (2): 131.

2. TECHNOLOGY DEVELOPMENT

Every value activity embodies technology. The array of technologies employed in most firms is very broad, ranging from technologies used to prepare documents and transport goods to those embodied in processes and equipment or the product itself. Technology that is related to the product and its features supports the entire value chain, while other technology development is associated with particular primary or support activities.

We discuss some of the innovations in products and services that promise to emerge from the 2000 merger of Allied Signal and Honeywell. These include innovations in performance materials and control systems.

q What are some of the most important technological innovations? Are there possible "downsides"? Why? Why not?

STRATEGY SPOTLIGHT 3.4 discusses a rather innovative technology that should be of interest to students – a seaworthy foldable boat. The example provides an interesting instance of its use – a mountain rescue service – and how innovative technology eliminates leaks.

One of the major functions of universities is to generate research that is useful to society. The SUPPLEMENT below addresses some of the recent technological innovations and discoveries that have been developed at universities.

SOME EXAMPLES OF UNIVERSITY-BASED TECHNOLOGY INNOVATIONS

Below are three examples of recent innovations that have been recently developed at universities:

• Scientists have vastly underestimated the number of whales that inhabited the North Atlantic before the advent of whaling, say geneticists at Stanford University and Harvard University. By studying the DNA of whales, the researchers were able to estimate that there were some 2 million great whales in the 18^th century — roughly 10 times than previously thought. Their findings are seen by conservationists as evidence that the ban on whaling should be extended for several more decades.

• For the 4 million Alzheimer's patients in the United States, new hope has just surfaced. Researchers at Harvard Medical School and Boston's Beth Israel Deaconess Medical Center report that an enzyme dubbed Pin1can prevent the brain's neurons from forming the deviant tangles characteristic of Alzheimer's. Comparisons of Pin1 levels in healthy versus afflicted human brains, plus laboratory tests on mice show that the tangles are clearly associated with an absence of Pin1. Using gene therapy to restore the enzyme to normal levels — although extremely challenging to do — might therefore arrest the progress of the disease.

• Athletes like creatine for its brawn-building benefits. Now it turns out this compound, which occurs naturally in humans, may also enhance memory. In a study at Australia's University of Sydney, a group of young adult vegetarians who received a daily five-gram dose of the supplement had a boost in working memory. The researchers did not determine the duration of this improvement or the long-term consequences of using creatine.

Source: Aston, A. 2003. Innovations. BusinessWeek, September 8: 105; and, Port, O. 2003. Innovations. BusinessWeek, August 11: 53.

q What do you think the role of research should be at universities (versus teaching and service)? (You will probably get some interesting discussion with some students claiming that universities should focus on teaching while others would stress the relationships between the teaching, research, and service missions.)

3. HUMAN RESOURCE MANAGEMENT

Human resource management consists of activities involved in the recruiting, hiring, training, development, and compensation of all types of personnel. It supports both individual primary and support activities (e.g., hiring of engineers and scientists) and the entire value chain (e.g., negotiations with labor unions).

In this section, we address JetBlue Airways' innovative "family friendly" initiative and AT & T's use of the internal labor market for talent.

q What are the advantages of JetBlue Airways' and AT & T's innovative approaches to human resource management? Could these types of programs be used at companies with which you are familiar? Why? Why not?

STRATEGY SPOTLIGHT 3.5 provides an insightful discussion of how SAS justifies the broad array of benefits it provides to all employees. This should be interesting to students because often they may feel that such "expensive programs" do not have financial payoffs.

q Could SAS Institute's approach be used at other organizations? Why? Why not?

Teaching Tip: While discussing the various support activities, ask those students who have some work experience whether or not the Human Resource Management function at their organization was well integrated with other value-creating activities such as operations, marketing, and procurement. Then you can address the issue of whether or not such relationships help to create value for the organization. (Interestingly, some students may point out that there were indeed interactions, but these actually were negative and bureaucratic in nature and eroded value.)

4. FIRM INFRASTRUCTURE

Firm infrastructure consists of a number of activities, including general management, planning, finance, accounting, legal, government affairs, quality management, and information systems. Infrastructure (unlike other support activities) typically supports the entire value chain and not individual activities.

This section addresses how firm infrastructure can be used as a source of competitive advantages — not merely as "overhead expenses." We provide examples of the symbolic leadership of CEOs such as Hewlett-Packard's Carleton (Carly) Fiorina, Walgreen Drug's information systems, and how the legal services at Texas Instruments were able to generate significant cash flows for the firm via its patent portfolio.

STRATEGY SPOTLIGHT 3.6 discusses how Gary Kelly, Southwest Airlines' Chief Financial Officer, adds value for his firm. His approach is key to Southwest's liquidity and strong financial performance in an extremely competitive industry in the past few years.

The SUPPLEMENT below discusses an important general administration activity —legal — that can generate significant value for companies. We address how patenting of technological innovations has benefited IBM. (Clearly, patent attorneys have to work very closely with scientists and engineers to be successful in obtaining valuable patents.)

IBM'S SUCCESSFUL PATENTING STRATEGY

The number of patents granted is increasing and, apparently, becoming more valuable. In 2004, IBM was awarded 3,248 of them by America's patent office — 68 percent more than second place Matsushita. IBM has been top of the list for 12 years in a row, often beating its rivals by more than 50%.

Such rankings shed light on both the past and the future of the technology industry. Typically, it takes between three and five years to obtain a patent, so the 2004 crop reflects applications filed at the turn of the century. Patent protection lasts for 20 years from the filing date, giving successful applicants long-term exclusivity on their invention. Each of the leading patent winners has a backlog of over 1,000 applications at the U. S. patent office.

IBM spends over $5 billion a year on R&D. It earns over $1.2 billion by licensing intellectual property (IP) protected by patents. According to Jim Stallings, IBM's vice-president of IP: "We built a model that lets us invest and identify ways to differentiate our products, and also to give others access to our technology. That lets us ensure we leverage the investment we make in R&D."

Source: Anonymous. 2005. Smart assets. The Economist. February 19: 60.

C. INTERRELATIONSHIPS AMONG VALUE CHAIN ACTIVITIES WITHIN AND ACROSS ORGANIZATIONS

Up to now, we have addressed value chain activities separately. Here, we discuss: (1) interrelationships among activities within the firm, and, (2) relationships among activities with other organizations, such as suppliers and customers.

We first review the examples of AT & T's Resource Link Program and Campbell Soup's Electronic Data Interchange (EDI) to demonstrate interrelationships within the firm and relationships with other organizations, respectively.

Then, we present the example of Ciba Specialty Chemicals (now part of Novartis), a Swiss manufacturer of textile dyes. Their innovation of dyes that fix more readily to the fabric and require less salt provides significant advantages for their customers.

STRATEGY SPOTLIGHT 3.7 addresses how Cardinal Health works to create value for both its suppliers and customers. This example serves to illustrate the importance of viewing one's firm as part of a value chain system composed of a focal firm as well as its suppliers, customers, and alliance partners.

D. APPLYING THE VALUE CHAIN TO SERVICE ORGANIZATIONS

We added this section on how to apply the value chain concept to service organizations in order to help show how it can be applied to firms other than manufacturing firms (which is what Porter's generic value chain concept can be most directly applied). We provide Circuit City (retail) and Arthur D. Little (technology-based consulting company) as illustrations. EXHIBIT 3.4 includes a depiction of the primary activities for each of these firms.

Transparency XX (Ex. 3.4) Some Examples of…

Ask:

q What would be some of the important support activities for these two firms?

q What are the key relationships among the primary and support activities to create value for these firms?

II. RESOURCE BASED VIEW OF THE FIRM

The resource-based view of the firm (RBV) combines two perspectives: (1) the internal analysis of phenomena within a company, and (2) an external analysis of the industry and its competitive environment. It extends SWOT analysis by combining internal and external perspectives and provides a useful framework for exploring why some firms are more successful than others.

EXHIBIT 3.5 addresses the types of resources that firms possess: tangible resources, intangible resources, and organizational capabilities.

q What are some examples of firms that are particularly strong (or weak) with regard to the items in Exhibit 3.5?

q Can you provide examples of firms that have effectively (or ineffectively) integrated their strengths regarding some of the items in Exhibit 3.5?

Throughout this section we focus on the importance of integrating value-creating activities, i.e., that competitive advantages are created (and sustained) through the bundling of several resources in unique combinations.

A. TYPES OF RESOURCES

This rather brief section discusses each of the three types of resources — tangible, intangible, and capabilities — and provides examples from business practice.

Tangible resources are assets that are relatively easy to identify and include financial, physical, organizational, and technological resources that an organization uses to create value for its customers. We provide the example of FedEx's computer-based job competency tests.

Intangible resources are much more difficult for competitors to account for or imitate. These include human resources, innovation resources, and reputation resources. The example of Harley-Davidson's strong brand image is addressed.

Organizational capabilities are not specific tangible or intangible assets. They are competencies or skills that a firm employs to transform inputs into outputs. We present the example of Gillette's capabilities to combine several technologies in its wet-shaving products.

EXHIBIT 3.5 and the discussion on pages 93-94 address how Dell Computers' resources and organizational capabilities have enabled them to become dominant in the personal computer (PC) industry.

B. FIRM RESOURCES AND SUSTAINABLE COMPETITIVE ADVANTAGES

For a firm to earn a sustainable competitive advantage, it must have four attributes: valuable, rare, and difficult for competitors to imitate or substitute. We provide the example of Priceline.com and how this firm attained early success. However, its advantage was eroded due to imitation by competitors. EXHIBIT 3.7 addresses these four criteria and their implications.

To encourage student discussion, ask the students:

q What are some examples of products (and services) that did not possess these four characteristics and subsequently did not provide sustainable advantages for the firm?

The SUPPLEMENT below addresses the vast variety of consumer products on the market — giving additional credence to the argument that it is difficult to attain advantages that (typically) are not eroded over time.

The vast variety of consumer products

Imitation products have proliferated the consumer products market with 31,000 new consumer products in 2000 alone. The average grocery store stocks 40,000 items. There are 16 flavors of Kellogg Eggo waffles, nine kinds of Kleenex brand tissue, 19 varieties of Colgate toothpaste, and innumerable garbage can liners in scented, unscented with twist, drawstring, and handle ties.

Procter & Gamble offers 19 varieties of Pert shampoo and 72 varieties of Pantene hair care products. Unilever has bucked the trend by decreasing its consumer products from 1,600 products to a mere 970 in the year 2000. The bottom line: It's not possible to attain sustainable advantages if your products don't satisfy the four RBV criteria.

Source: Nelson, E. 2001. Too many choices. The Wall Street Journal, April 23: B1, B4.

We will now discuss each of the four criteria.

1. IS THE RESOURCE VALUABLE?

Resources are valuable when they enable a firm to formulate and implement strategies that improve its efficiency or effectiveness. The SWOT framework suggests that firms improve their performance only when they either exploit opportunities or neutralize (minimize) threats.

2. IS THE RESOURCE RARE?

If competitors or potential competitors also possess the same valuable resource, it is not a source of competitive advantage because all of these firms have the capability to exploit the resource in the same way. Common strategies based on such a resource would give no one firm an advantage. For a resource to provide a competitive advantage, it must be uncommon, that is, rare relative to other competitors.

3. IS THE RESOURCE IMITATED EASILY?

Inimitability is a key to value creation because it constrains competition. If a resource is inimitable, then any profits generated are more likely to be sustainable.

We discuss the example of Iowa Beef Processors (IBP). Although this firm was the first to modernize its facilities and capabilities, competitors easily duplicated its efforts. This drove down their profitability.

For imitation to be avoided, four conditions need to be satisfied:

Physical uniqueness. By definition it is inherently difficult to copy. Examples would include a beautiful resort location, mineral rights, or Merck & Co.'s pharmaceutical patents.

Path Dependency. This means that resources are unique and therefore scarce because of all that has happened along the path followed in their development and/or accumulation. We provide the examples of Gerber Products Co. and Southwest Airlines.

Causal Ambiguity. This means that would-be competitors may be thwarted because it is impossible to disentangle the causes (or possible explanations) of either what the valuable resource is or how it can be created. We discuss 3M's process of innovation as well as Continental Airlines' failure to imitate Southwest Airlines' successful low-cost strategy.

Social Complexity. These include "soft" issues such as culture, trust, and leadership. Examples include interpersonal relations among the employees and managers of a firm, its culture, and its reputation among suppliers and customers. Although complex physical technology is not included in this category of imperfect inimitability, the exploitation of physical technology in a firm typically involves the use of socially complex resources.

The SUPPLEMENT below discusses the market for corporate real estate and the importance of personal relationships and insider knowledge. It serves to drive home the point that competitive advantages are difficult to attain or sustain for new entrants. This is because some intangible assets may be difficult to imitate.

Corporate real estate:
The importance of personal relationships and insider knowledge

The market for corporate real estate leases, including apartment buildings, office buildings, retail malls, and warehouses, is a largely fragmented market. There is no central source corporate clients can turn to when they are looking to lease these types of facilities. But a promising new venture, Zethus, Inc. backed by $15 million of venture capital form Goldman Sachs, hoped to change the way business was done in this industry. Zethus hoped to become a central source for locating corporate real estate by bringing together tenants and landlords. Jim Hime, founder of the new venture, intended to use the Internet to broker the relationship between interested parties. However, he found that "the industry thrives on intricate personal relationships and insider knowledge." This is a prime example of a service that is difficult to imitate.

Hime's company, founded in 1999, at first intended to replace brokers by bringing together landlords and tenants on Zethus's website. But when he found that this would not work due to personal relationships involved in the business, he began to target the brokers themselves. His sales pitch was that Zethus would act as a neutral party to the deal for a small portion of the commission. He was unable, however, to convince brokers that he was looking out for their best interests.

Source: Rich, S. 2001. Why a plan to list office properties on the Web failed. The Wall Street Journal, April 21: B2, B3.

4. ARE THERE READILY AVAILABLE SUBSTITUTES?

The fourth requirement for a firm to be a source of sustainable competitive advantage is that there must be no strategically equivalent valuable resources that are themselves not rare or inimitable.

Substitutability may take at least two forms. First, although it may be impossible for a firm to imitate another firm's resource exactly, it may be able to substitute a similar resource that enables it to develop and implement the same strategy. We provide the example of roughly equivalent top management teams. Second, very different firm resources can become strategic substitutes. We provide the example of Internet booksellers such as Amazon.com as substitutes to brick-and-mortar booksellers such as B. Dalton and Crown. The result is that premier real estate becomes less valuable. We also discuss the viability of roughly equivalent drug therapies that treat similar maladies.

EXHIBIT 3.8 illustrates the relationship among the four criteria of sustainability and shows the competitive implications.

q What may be example(s) of companies that illustrate each of the four conditions?

C. THE GENERATION AND DISTRIBUTION OF A FIRM'S PROFITS: EXTENDING THE RESOURCE-BASED VIEW OF THE FIRM

The key point in this section is that even though a firm may have a source of competitive advantage that appears to satisfy the four criteria for sustainability, some (or a good deal) of its profits may be retained (or "appropriated") by its employees or managers—instead of going to the owners (i.e., shareholders).

We address four conditions that explain the extent to which managers and employees will be able to extract a proportionately high level of the profits they generate:

· Employee bargaining power

· Employee replacement cost

· Employee exit cost

· Manager bargaining power

Teaching tip: The discussion of the generation and distribution of a firm's profits between the firm and individual employees is a good opportunity to discuss some of the career implications for the students and enable them to realize the practical applicability of the concepts covered in this section. In this section, we address the four conditions that enable managers and employees to extract a disproportionate share of the profits that they generate. You may ask them to think back on people they have known in organizations who were either very successful or very unsuccessful and if their success (or lack thereof) could be explained by these four criteria. The career implications become rather self-evident.

III. EVALUATING FIRM PERFORMANCE: TWO APPROACHES

Here, we address two major approaches to evaluating firm performance. The first is financial ratio analysis in which we assess how a firm is doing compared to its balance sheet, income statement, and market valuations.

Second, we address performance from the perspective of a broader stakeholder perspective. Kaplan and Norton's concept of the balanced scorecard is central to our discussion.

A. FINANCIAL RATIO ANALYSIS

We address five different types of financial ratios:

· Short-term solvency or liquidity

· Long-term solvency measures

· Asset management

· Profitability

· Market value

We also provide an APPENDIX to this chapter to provide detailed definitions and discussions of each of these types of ratios; including examples of how they are calculated.

(All of your students have been exposed to this information in their accounting and finance classes but it is worthwhile to spend some time in review.)

Next, we address some issues that must be taken into account in order to make financial analysis more meaningful: historical comparisons, comparisons with industry norms, and comparisons with key competitors.

1. HISTORICAL COMPARISONS

Comparing a firm's performance over time helps to provide a means of evaluating trends. We provide the example of Nissan's improved performance between 1999 and 2000. EXHIBIT 3.9 illustrates a ten-year period of return on sales for a hypothetical company. As indicated by the dotted trend lines, the rate of growth (or decline) differs substantially over time periods.

At times, historical comparisons may need to be used with caution. For example, the SUPPLEMENT below provides some specific information on how percentage increases can, in effect, distort reality. Consider how some specific data on percentage in the export of U. S. automobiles to Japan many years ago could be misleading.

U.S. car sales to Japan — The importance of "relative" sales volume

Percentage increases may imply that U.S. automakers made inroads in the Japanese markets a decade ago. However, such apparent optimism is eroded when absolute numbers are addressed. Though sales climbed 800 % between 1985 and the early 1990's, total sales of the Big Three in Japan were only about 17,000 in 1991. (This figure represents only about one month's production at a typical automobile plant!) Meanwhile, Japanese automakers sold approximately 3.3 million cars in the U. S. in 1991 — a factor of nearly 200!

Source: Miller, K. L. 1991. What's this? American cars gaining in Japan. Business Week: July 22: 82-83.

2. COMPARISONS WITH INDUSTRY NORMS

When evaluating a firm's financial performance, it is important to compare it with industry norms. That is, a firm's current ratio or profitability may be impressive at first glance. However, it may pale when compared to industry averages.

EXHIBIT 3.10 compares financial ratios for three different industries — semiconductors, grocery stores, and skilled nursing facilities. Although the text provides a brief discussion of why there is such variation among these industries, it may still be useful to pose this question — to reinforce learning and obtain additional insights.

3. COMPARISONS WITH KEY COMPETITORS

Referring back to Chapter 2, firms with similar strategies are considered members of strategic groups in a given industry. Furthermore, competition tends to be more intense among competitors within groups than across groups. Thus, one can gain valuable insights into a firm's financial and competitive position if comparisons are made between a firm and its most direct competitors.

EXHIBIT 3.11 points out the importance of comparing financial figures to key competitors. Although Procter & Gamble's R&D budget for drugs may be quite large in an absolute sense--$380 million, it pales in comparison to the major competitors in this industry such as Bristol-Myers Squibb, Pfizer, and Merck.

B. INTEGRATING FINANCIAL ANALYSIS AND STAKEHOLDER PERSPECTIVES: THE BALANCED SCORECARD AND THE STRATEGY MAP

1. THE BALANCED SCORECARD

The balanced scorecard helps to provide a meaningful integration of many issues that come into play when evaluating a firm's performance. It is a set of measures that provide top managers with a fast but comprehensive view of the business. In a nutshell, it includes financial indicators, operational measures of customer satisfaction, internal processes, and the organization's innovation and improvement activities.

The balanced scorecard enables managers to consider their business from four key perspectives:

· How do customers see us? (customer perspective)

· What must we excel at? (internal perspective)

· Can we continue to improve and create value? (innovation and learning perspective)

· How do we look to our shareholders? (financial perspective)

2. CUSTOMER PERSPECTIVE

Managers must translate their general mission statements on customer service into specific measures that reflect the factors that really matter to customers. There are four primary categories of customer concerns: time; quality; performance and service; and cost.

3. INTERNAL BUSINESS PERSPECTIVE

Customer-based measures are important. However, they must be translated into indicators of what the firm must do internally to meet customers' expectations. The internal measures should reflect business processes that have the greatest impact on customer satisfaction. This includes factors such as cycle time, quality, employee skills, and productivity.

4. INNOVATION AND LEARNING PERSPECTIVE

Given the rapid rate of change in markets, technologies, and global competition, the criteria for success are constantly changing. Accordingly, a firm's ability to improve, innovate, and learn ties directly to its value. That is, only by developing new products and services, creating greater value for customers, and increasing operating efficiencies, can a company penetrate new markets, increase revenues, and grow shareholder value.

q Should other companies use Tivoli's approach? If so, how should it be organized?

5. FINANCIAL PERSPECTIVE

Such measures indicate whether the company's strategy, implementation, and execution are, in fact, contributing to bottom-line improvement. Typical financial goals include profitability, growth, and shareholder value. Periodic financial statements remind managers that improved quality, response time, productivity, and innovative products benefit the firm only when they result in improved service, increased market share, reduced operating expenses, or higher asset turnover.

We Discuss the example of Sears, the giant U. S. retailer to illustrate the strong causal relationships among employee attitudes, customer attitudes, and financial outcomes. This should come across as an interesting example in that many "hard to quantify" concepts are, in fact, accurately measured.

The SUPPLEMENT below serves as a "caveat" to the use of the balanced scorecard. That is, it emphasizes that the alleged linkage between improved operating performance and financial success can be quite tenuous and uncertain.

The tenuous linkage between financial success and operating performance

Over a three-year period between 1987 and 1990, a NYSE electronics company made a significant improvement in quality and on-time delivery performance. Outgoing defect rates dropped from 500 parts per million to only 50, on-time delivery improved from 70 % to 96%, and yield soared from 26 % to 51 %. Unfortunately, these breakthrough improvements in quality, productivity, and customer service did not provide substantial financial benefits to the company.

During the same period of time, the firm's financial results showed little improvements and the stock price eroded to one-third of its July 1987 value. Why? The considerable improvements in manufacturing capabilities had not been translated into increased profitability. Slow releases of new products and a failure to expand marketing to new and perhaps more demanding customers prevented the company from realizing the benefits of its manufacturing achievements. The operational achievements were real, but the company failed to capitalize on them.

Source: Kaplan, R. S. & Norton, D. P. 1992. The balanced scorecard—Measures that drive performance. Harvard Business Review, 70 (1): 77.

Teaching Tip: During the discussion of the Balanced Scorecard, it is important to bring to the class' attention that there are inevitable tradeoffs between the elements in the balanced scorecard. What are the challenges involved in balancing these tradeoffs? You may point out that at a given time a firm may focus on a goal that is more pressing at that point in time. You may also point out that a firm can focus on different elements at different points in time, building on the success in one area to improve in another.

In addition to the tradeoffs that we discussed in the above SUPPLEMENT, there have been other critical commentaries on the use of the Balanced Scorecard concept. We include this discussion not to discount its potential value, but rather to add an additional perspective on this widely used strategy tool.

In the SUPPLEMENT below, we summarize some of the problems/challenges that users have discovered in using the Balanced Scorecard:

SOME CHALLENGES IN USING THE BALANCED SCORECARD

Although Canada has embraced the use of balanced scorecards, there has hardly been universal positive response. An estimated 65% to 70% of organizations have used them and their use is increasing.

A few users — about 10% — insist that their scorecards are attaining positive results and meet with spirited rebuttal suggestions that balanced scores do not work. In contrast, a much larger group doubts that scorecards achieve sustained financial performance.

The overwhelming view seems to be that balanced scorecards can be worthwhile in clarifying an organization's strategy and that if this can be accomplished, better results should follow. A few companies stated categorically that scorecards have made a positive difference in their firm's financial results. A typical statement was, "We did not meet our financial goals previously, but since implementing our balanced scorecard, we have now met our goals three years running." In contrast, a larger number agreed with the statement, "Balanced scorecards don't really work." Comments included: "It became just a number-crunching exercise by accountants after the first year;" "It is just the latest management fad and is already dropping lower on management's list of priorities as all dads eventually do;" "We found it very complex to implement;" and, "If scorecards are supposed to be a measurement tool, why is it so hard to measure their results?"

A summary of some of the key problems that can be associated with Balanced Scorecards include:

· Emphasis on financial measures rather than nonfinancial, leading to measures that do not connect to the drivers of the business and are not relevant to performance improvement

· Too many objectives defined and too many performance metrics being measured to enable the organization to prioritize improvements steps adequately

· Poor data on actual performance, negating most of the effort invested in defining performance measures by not being able to monitor actual changes in results from changes in behavior

· Managers not communicating the cultural change clearly and continuously, supported by management deeds that confirms that management is serious.

· An implementation plan that is not grounded in reality and unable to respond quickly to unforeseen events.

Source: Angel, R. & Rampersad, H. 2005. Do scorecards add up? Camagazine.com, May: np.

Teaching Tip: You might consider asking the following question prior to discussing the material in the supplement above: What do you think are some of the problems that can potentially be expected with the use of the Balanced Scorecard. Or, if your students, as a group, have a relatively large amount of business experience, you may ask them: What has been your experience with the use of the Balanced Scorecard in your organization? Has it worked well? Why? or, Why not?

2. THE STRATEGY MAP

We close the chapter with a discussion of the concept of the "strategy map," which is a further refinement of Kaplan and Norton's "balanced scorecard." Strategy maps endeavor to indicate the case and effect links by which specific improvements in different areas lead to a desired outcome. Strategy maps also help employees see how their jobs are related to the overall objectives of the organization. They also serve to clarifying how an organization can convert its assets, both tangible and intangible, into tangible outcomes.

EXHIBIT 3.12 illustrates how to develop a strategy map using ExxonMobil as an example.

Transparency XX (Ex. 3.12) ExxonMobil's Strategy Map

IV. SUMMARY

In traditional approaches to assessing a firm's internal environment, a manager's primary goal would be to determine her firm's relative strengths and weaknesses. Such is the role of SWOT analysis, wherein a manager analyzes her firm's Strengths and Weaknesses as well as the Opportunities and Threats in the external environment. In this chapter, we discussed why this may be a good starting point but hardly the best approach to performing a sound analysis. There are many limitations of SWOT analysis, including its static perspective, its potential to overemphasize a single dimension of a firm's strategy, and the likelihood that a firm' strengths do not necessarily help the firm create value or competitive advantages.

We identified two frameworks that serve to complement SWOT analysis in assessing a firm's internal environment: value chain analysis and the resource-based view of the firm. In conducting a value chain analysis, you first divide the firm into a set of value creating activities. These include primary activities such as inbound logistics, operations, and service as well as support activities such as procurement and human resources management. Then you analyze how each activity adds value as well as how interrelationships among value activities in the firm and among the firm and its customers and suppliers add value. Thus, instead of merely determining a firm's strengths and weaknesses per se, we analyze them in the overall context of the firm and its relationships with customers and suppliers, the value system.

The resource-based view of the firm considers the firm as a bundle of resources: tangible resources, intangible resources, and organizational capabilities. Competitive advantages that are sustainable over time generally arise from the creation of bundles of resources and capabilities. For advantages to be sustainable, four criteria must be satisfied: rareness, valuable, difficulty in imitation, and difficulty in substitution. Such an evaluation requires a sound knowledge of the competitive context in which the firm exists. The owners of a business may not capture all of the value created by the firm. The appropriation of value created by a firm between the owners and employees is determined by four factors: employee bargaining power, employee replacement cost, employee exit costs, and manager bargaining power.

An internal analysis of the firm would not be complete unless you evaluated its performance and made the appropriate comparisons. Determining a firm's performance requires an analysis of its financial situation as well as a review of how well it is satisfying a broad range of stakeholders, including customers, employees, and stockholders. We discuss the concepts of the balanced scorecard and strategy map, in which four perspectives must be addressed: customer, internal business, innovation and learning, and financial. Central to the balanced scorecard is the idea that the interests of various stakeholders can be interrelated. We provide examples of how indicators of employee satisfaction lead to higher levels of customer satisfaction, which in turn lead to higher levels of financial performance. Thus, improving a firm's performance does not need to involve making tradeoffs among different stakeholders. Assessing the firm's performance is also useful if it is evaluated in terms of how it changes over time, compares with industry norms, and compares it with key competitors.

PowerPoint:Analyzing the External Environment of the Firm

2007-05-03T06:40:00.000-07:00

Analyzing the External Environment of the Firm

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SUMMARY/OBJECTIVES

The purpose of this chapter is to familiarize students with techniques for evaluating a firm's external environment. This chapter focuses on the value managers add when they have a sense of events outside the company. By focusing on external events, managers are able to stay a step ahead of competitors by accurately anticipating and promptly responding to actions that can impact the organization. The chapter is organized into three sections.

1. The environmentally aware organization. Emphasize that managers use scanning, monitoring, and competitive intelligence to develop forecasts. Also, the role of scenario planning is discussed.

2. The influence of the six broad segments (demographic, sociocultural, political/legal, technological, macroeconomic, global) of the general environment of the firm.

3. The role of the competitive (also called the task or industry) environment and its analysis through the application of Porter's five forces model. We also address the concept of strategic groups. Managers use strategic groups to identify who its main competitors are and how a company fits in with the overall industry in which it competes.

LECTURE/DISCUSSION OUTLINE

The introductory case is Interstate Bakeries Corporation's failure to respond to trends in the baking industry. Use the example to illustrate how a firm's failure to recognize trends in consumer preference, the industry, and among competitors can cause business failures. Explain that scanning, monitoring, and competitive intelligence are all separate, discrete techniques that lead to business forecasts.

q What are the key points in the case?

q What other organizations have misread their external environment? What were the consequences?

I. THE ENVIRONMENTALLY AWARE ORGANIZATION

We address three important processes—scanning, monitoring, and gathering competitive intelligence—which managers use to develop forecasts. EXHIBIT 2.1 depicts relationships among these activities. Also, we address scenario planning and its role in anticipating future major changes in the external environment as well as the role of SWOT analysis.

The SUPPLEMENT below provides an historical perspective of the need for environmental awareness from the computer industry. This is, of course, an industry with which the students should be more familiar. (The authors are consultants with McKinsey & Company in Palo Alto, California.)

Environmental Awareness and the Computer Industry

In the late 1970s, huge, vertically integrated companies like Burroughs, IBM, and Digital Equipment dominated the computer industry. With their vast scale advantages and huge installed bases, they seemed unassailable. Yet just ten years later, the power in the industry had shifted. The behemoth firms were struggling to survive while armies of smaller, highly specialized companies were thriving. What happened?

The industry's sea change can be traced back to 1978 when a then tiny company, Apple Computer, launched the Apple II personal computer. The Apple II's architecture unlocked the computer business, allowing the entry of new companies that specialized in producing specific hardware and software components. Immediately, the advantages of the generalist—size, reputation, vertical integration—began to whither. The new advantages—creativity, speed, and flexibility—belonged to the specialist… As a result, tightly coordinated webs of specialized companies—with names like Apple, Intel, Microsoft, Sun Microsystems, and Adobe—could form and ultimately compete against the entrenched, vertically integrated giants…

The Lesson: Executives will be forced to ask the most basic question about their companies: What business are we really in?

Source: Hagel, J. III & Singer, M. 1999. Unbundling the corporation. Harvard Business Review, 77(2): 133-139.

A. ENVIRONMENTAL SCANNING

Environmental scanning involves surveillance of the firm's external environment to predict environmental changes to come and detect changes that are already underway. We discuss the examples of (1) BP Amoco and (2) three of the eight "key issues" (globalization; time to market; and shifting roles and responsibilities) facing the automobile industry according to A. T. Kearney.

q Why would an automobile executive be at a disadvantage if s/he were not aware of such trends?

B. ENVIRONMENTAL MONITORING

Environmental monitoring tracks the evolution of trends, events, or streams of activities

in the external environment. In this section, we present some of the factors monitored by three organizations: Motel 6, Pier 1 Imports, and Johnson and Johnson Medical Products. Such factors are vital for managers in determining their firm's strategic direction and resource allocations.

The SUPPLEMENT below represents the factors that the Director of Planning of Vought Aircraft considered critical. You may initially ask the students:

q What indicators do you believe a firm should monitor that produces both (1) weapon systems for the military, and, (2) key components for the commercial aircraft industry?

Factors to Monitor—Vought Aircraft

Commercial Aircraft:

1. Oil prices

2. Age of fleet of airlines

3. Profitability of airlines

Defense Department:

1. Where weapons are in the life cycle

2. Mission requirements of the military

Source: Authors' interviews.

C. COMPETITIVE INTELLIGENCE

Competitive intelligence helps firms define and understand their industry and identify rivals' strengths and weaknesses. Done properly, competitive intelligence helps a company to avoid surprises by effectively anticipating and responding to competitors' moves.

We briefly address the importance of competitive intelligence to firms in the banking, airline, and automobile industry.

q What are other industries where competitive intelligence is extremely important? How might such information be collected?

We address how the Internet has accelerated the speed at which firms can find competitive intelligence.

The following SUPPLEMENT provides an interesting perspective by Tracey Scott, past president of the Society of Competitive Intelligence Professionals:

The "People Side" of Competitive Intelligence

"I distinguish between secondary information—stuff that you read on the Web or in reports—and human-source information: stuff that real people tell you. Human-source information is more interesting and more accurate than secondary information. That's why I always look for 'star talent' and think about what the comings and goings of those people mean. I also love conference proceedings. Most companies send their best people to speak at conferences. It's a great way to track talent and to track down people who might have useful information and insights."

Source: Imperato, G. 1998. Competitive intelligence: Get smart. Fast Company. April-May: 270.

q Do you agree with Ms. Scott's perspective? Do you feel she overstates her case? Why? Why not?

EXHIBIT 2.2 further clarifies what competitive intelligence (CI) is all about. It provides four contrasting issues on what CI "is" and "is not."

STRATEGY SPOTLIGHT 2.1 discusses some of the ethical guidelines that United Technologies has implemented.

q Are you aware of ethical guidelines that other companies have developed? Were they effective? Why? Why not?

Teaching Tip: The discussion of Competitor Intelligence provides the instructor with an opportunity to introduce the subject of ethics into the classroom. We suggest presenting scenarios that are not "black and white." For example, a firm advertises a position in order to get a chance to interview employees of a rival company with no intention to hire them. While this may not be illegal, clearly it is difficult to justify morally. The ensuing discussion will help to clarify the distinction between illegal and unethical behavior.

D. ENVIRONMENTAL FORECASTING

Environmental scanning, monitoring, and competitive intelligence are important inputs for analyzing the external environment. However, they are of little use unless they provide raw material that is accurate enough to help managers make accurate forecasts.

We address the twin problems of either assuming that the world is certain and open to precise predictions, or the assumption that it is uncertain and totally unpredictable. And, we provide the famous example of poor forecasting of the British/French supersonic transport, the Concorde.

q What are some other errors in forecasting with which you are familiar?

The SUPPLEMENT below provides an example of how a retail firm, Japan-based World Company and Spain-based Zara estimate future demand for their products:

Forecasting in the retail industry

Early product sales, appropriately adjusted for variations in price and availability, are an excellent predictor of overall sales. In fact, retailers that exploit these data for production and inventory planning can more than double their profits—especially retailers of products with short life cycles, such as clothing, consumer electronics, books, and music.

Several companies have retailing practices worth emulating. Japan-based World Company and Spain-based Zara are fashion retailers whose merchants systematically examine early sales data to estimate future demand for their products. They conduct this analysis for every product at pre-determined periods in its sales cycle. And the merchants follow through, immediately reordering items that look as though they might end up in short supply. Not surprisingly, World Company has attained a gross-margin return on inventory investments of more than 300 percent—a substantially higher return than any other retailer that we are aware of.

Source: Fisher, M. L., Raman, A., & McClelland, S. 2000. Rocket science retailing is almost here—Are you ready? Harvard Business Review, 78 (4): 116.

Scenario planning provides a set of tools that enable managers to imagine threats and opportunities the future may bring. As a general rule, scenarios should be used by businesses whose external environments are prone to fundamental or sudden change and whose anticipation of such change is of vital strategic importance.

It is important to note that scenario planning draws on a wide range of disciplines and interests, among them economics, psychology, sociology, and demographics.

q Why must scenario planning draw on a variety of disciplines and interests?

We provide the example of Lego, and how its position in the toy industry may become eroded if they define their industry—and its future—in a very narrow context.

STRATEGY SPOTLIGHT 2.2 includes the example of Shell Oil Company has benefited from the use of scenario analysis.

F. SWOT Analysis

We briefly address SWOT Analysis at this point. SWOT stands for strengths, weaknesses, opportunities, and threats. SWOT analysis provides a framework for analyzing these four elements of a company's internal and external environment.

It is important to note that SWOT analysis provides the "raw material", that is, a basic listing of conditions and factors inside and outside of a company.

q What do you consider to be some of the major advantages and disadvantages of SWOT analysis? (This issue is addressed in more detail in Chapter 3, but you should point out that a key disadvantage is that strengths may not necessarily convert to sources of competitive advantage that are sustainable in the marketplace.)

II. THE GENERAL ENVIRONMENT

The general environment consists of factors that can have a dramatic effect on a firm's strategy. Typically, a firm has little ability to predict trends and events in the general environment, and even less ability to control them.

We divide the general environment into six segments: demographic, sociocultural, political/legal, technological, economic, and global.

EXHIBIT 2.3 provides examples of key trends and events in each of the six segments of the general environment

q How will the factors in Exhibit 2.3 affect specific industries?

q Which factors are more difficult to predict than others? (e.g., macroeconomic changes are typically more difficult to predict than demographic changes)

q How are these factors interrelated?

q What factors do you feel are important that are not listed in this exhibit?

A. THE DEMOGRAPHIC SEGMENT

Demographics are the most easily understood and quantifiable elements of the general environment. Demographics include elements such as the aging population, rising or declining affluence, changes in ethnic composition, geographic distribution of the population, and income level disparities.

q What are the implications of ethnic diversity for the work place?

q What implications do the migration to the South and West in the United States have for individual businesses?

q How does the "graying of America" affect U. S. companies?

Among the trends we discuss are the aging of the population and how it may differentially affect a wide variety of industries. We also discuss the increasing number of wealthy Americans as well as changes in the geographic population of the United States.

The SUPPLEMENT below, building upon STRATEGY SPOTLIGHT 2.3, addresses some interesting projections on the "aging" workforce and its implications:

THE "AGING WORKFORCE" AND ITS IMPLICATIONS

In the United States, the overall rate of the workforce growth will face a sharp drop. After peaking at nearly 30 percent in the 1970s (as the baby boomers as well as unprecedented numbers of women entered the workforce), and holding relatively steady at 12 percent during the 1990s and the present decade, the rate is projected to level off at 2 to 3 percent per decade thereafter. This translates into an annual growth rate of less than 1 percent today and a tiny 0.2 percent by 2020. The proportion of workers over 55 declined from 18 percent in the 1970s to under 11 percent in 2000. However, it is projected to rebound by 20 percent by 2015. Stated another way, we have recently passed what will prove to be a historic low in the concentration of older workers. Just when we have gotten accustomed to having relatively few older workers around, we have to start learning how to attract and retain far more of them.

During the next 15 years, 80 percent of native-born workforce growth in North America—and even more so in much of Western Europe—is going to be in the over-50 cohort. In the next decade or so, when baby boomers—the 76 million people born between 1946 and 1964, more than on-quarter of all Americans—begin their sixties and contemplate retirement, there won't be nearly enough young people entering the workforce to compensate for their exodus. The Bureau of Labor Statistics projects a shortfall of 10 million workers in the United States in 2010, and in countries where the birthrate is well below the population replacement level (particularly Western Europe), the shortage will hit sooner, be more severe, and remain chronic.

Source: Dychtwald, K. Erickson, T. & Morison, B. 2004. It's time to retire retirement. Harvard Business Review, 82 (3): 48-57.

Ask:

q It might be interesting to ask what the implications are for today's organization (e.g., how can firms attract and retain older workers, changes in financial and non-financial incentives, etc.) as well as for public policy (e.g., changes in tax policies, increasing the number of immigrants, etc.).

STRATEGY SPOTLIGHT 2.3 discusses an important demographic trend – older employees in the workforce.

B. THE SOCIOCULTURAL SEGMENT

Sociocultural forces influence the values, beliefs, and lifestyles of a society. Examples include a higher percentage of women in the workforce, dual-income families, increases in the number of temporary workers, greater concern for healthy diets and physical fitness, greater interest in the environment, and families postponing having children.

q Name two industries that have benefited from the growing awareness about health and fitness. Also name two that have been adversely affected by this trend.

q What must firms do to attract and retain women employees? Why are such efforts becoming increasingly important?

The section also addresses the increased educational attainment of women in the workplace. We discuss increases in both the number of degrees granted to women as well as the increased formation of businesses by women.

STRATEGY SPOTLIGHT 2.4 discusses the significant role that women play in the making of important consumer decisions.

Ask:

q Can you think of any other important implications this trend has for businesses in a specific industry?

C. THE POLITICAL/LEGAL SEGMENT

Political processes and legislation influence the regulations with which industries must comply. Some important elements of the political/legal arena include tort reform, the Americans with Disabilities Act (ADA), the repeal of the Glass-Stegall Act in 1999 (now banks may offer brokerage services), deregulation of utilities and other industries, and increases in the federally mandated minimum wage.

q What do you see as some of the pros/cons of the Americans with Disabilities (ADA) Act?

q Do you think the federally mandated minimum wage should be increased? What are the implications?

q Should there be tort reform—such as setting limits on the amounts that juries can award in personal injury cases?

Another area where visa restrictions is having an important impact is "very close to home" — universities. In the SUPPLEMENT below we provide an example of one student who elected to attend an M.B.A. program in China (because of visa concerns in the United States) and the fact that applications from Asian students have declined by as much as 50 percent at some U.S. business schools.

LEGISLATION ON VISA RESTRICTIONS: ITS IMPACT ON U.S. BUSINESS SCHOOLS

Paul Foo was a very attractive M.B.A. applicant — he could have had his pick among America's most prestigious M.B.A. programs. A graduate of Cambridge University in England, he had worked for three years at an investment bank in his native Malaysia before applying to business school. The University of California at Berkeley offered him a half-tuition scholarship and Thunderbird in Arizona (American Graduate School of International Business) offered him a full scholarship. Although he felt the offers were tempting, he was concerned about immigration headaches.

Foo had heard horror stories about Asian M.B.A. students waiting up to six months for a visa to reenter the U. S. after summer break. He had also heard about difficulties finding jobs in the United States after graduation. Thus, Foo decided to attend the China Europe International Business School in Shanghai. (He even gave up a Fulbright Scholarship that was contingent upon his attending a university in the United States.)

Asian students are increasingly ignoring U. S. business schools, troubled by tougher U. S. immigration laws and enticed by China's rapid economic growth. Applications from Asian students are down by as much as 50 percent at U. S. business schools. This decrease is troubling since Asian students typically pay full tuition, says Richard E. Sorensen, chairman of the Association to Advance Collegiate Schools of Business.

Source: Ridgway, N. 2005. Brain drain. Forbes. September 5: 154.

In this section we address some of the implications of tort reform. We also discuss some of the implications of legislation that may expand the number of temporary visas available for highly skilled foreign professionals. (It may be interesting to pose questions on this issue given the September 11, 2001 terrorist attacks, i.e., whether or not the number of visas should be restricted in some manner.)

D. THE TECHNOLOGICAL SEGMENT

Developments in technology lead to new products and services and improve how they're produced and delivered to the end user. Innovations can create entirely new industries and alter existing industries.

q Ask students to speculate on the impact of the following technologies on American industry: (1) the Internet, (2) manufacturing innovations (e.g., robotics), (3) genetic engineering/designer genes. (The last items may provoke some heated discussion regarding the ethical implications.)

We discuss the key implications that the Internet has had on industry — in particular, its impact on productivity gains.

EXHIBIT 2.4 addresses a fascinating issue: some of the promising future applications of nanotechnology and how it will impact some industries.

The SUPPLEMENT below discusses how technology developed by NASA is making important contributions outside of the space program.

FIGHTING FIRES WITH SPACE-AGE TECHNOLOGY

During the summer of 2003, wildfires raged in a dozen states. Firefighters are turning to technology to curb the recent, unusually heavy forest-fire damage: 7 million acres over a recent 12-month period. This is nearly double the annual average in the 1990s.

NASA has developed tools to help the U. S. Forest Service to find and fight the blazes. Four times a day, NASA satellite images are passed to the Forest Service's fire management center in Salt Lake City. And soon, researchers at Rochester Institute of Technology could develop a remote-sensing system that could spot a foot-wide fire from an aircraft flying at 10,000 feet. NASA is also working to install the gear in unmanned aerial vehicles such as the robot spy planes that flew in Afghanistan and Iraq.

Source: Port, O. 2003. Fighting forest fires with space-age tools. BusinessWeek, August 11: 53.

We close out the section by addressing some of the "downsides" of technology. In addition to ethical issues, we discuss environmental damage, such as the emission of greenhouse gases. We discuss BP Amoco's innovative approach to this matter.

E. THE ECONOMIC SEGMENT

The economy has an impact on all industries, from suppliers of raw materials to manufacturers of finished goods and services, as well as all organizations in the service, wholesale, retail, government, and nonprofit sectors of economies. Key indicators include interest rates, unemployment rates, the consumer price index (CPI), the Gross Domestic Product (GDP), and net disposable income.

q Compare the impact of rising (or declining) interest rates on the overall demand for the following industries: (1) housing (will have a significant impact), (2) automobiles (will have a significant impact), (3) fast food (will have very little effect).

F. THE GLOBAL SEGMENT

Globalization provides both opportunities to access larger potential markets and a broad base of factors of production such as raw materials, labor, skilled managers, and technical professionals. However, such endeavors carry many political, social, and economic risks. Examples of important elements in the global segment include currency exchange rates, increasing global trade, the economic emergence of India, China's admittance to the World Trade Organization, trade agreements among regional blocs (e.g., EC), and the GATT Agreement (lowering of tariffs).

q Provide examples of firms that have succeeded (stumbled) in their efforts to expand into international markets. What factors can explain their success (failure)?

We discuss the globalization of the automobile industry — in particular, the attraction of developing markets. We provide the example of the Norwegian shipping industry to illustrate its global nature.

The SUPPLEMENT below addresses some of the issues pertaining to the global impact of the September 11, 2001 terrorist attacks in the United States and the "War on Terror." (You may consider posing a question on this issue prior to discussing the supplement)

The Global Implications of September 11, 2001

As companies worry more about the safety of their staff and facilities, the free flow of people and goods could slow, hurting economic efficiency. Because the higher cost of capital, investment won't return to boom-era levels. That, in turn, could mean that even when the United States emerges from recession, it will be hard-pressed to return to the 4 percent baseline growth it achieved during the go-go years of the 1990s. In short, America's golden age of prosperity—and the promise it held for global growth—may have hit its zenith.

Globalization certainly isn't going to disappear—the world's markets are too vitally integrated to roll back now. But globalization could well become slower and costlier, crimping the high-productivity, low-inflation model of the 1990s. Companies will likely have to pay more to insure and provide security for overseas staff and property. Heightened border inspections could slow movements of cargo, forcing companies to stock more inventory. And, tighter immigration policies could curtail the liberal inflows of skilled and blue-collar laborers who allow companies to expand while keeping wages in check.

Source: Engardio, P. 2001. What's at stake? Business Week. October 22: 35.

G. RELATIONSHIPS AMONG ELEMENTS OF THE GENERAL ENVIRONMENT

In our discussion of the general environment, we have addressed many relationships among the various elements.

EXHIBIT 2.5 provides many examples of how the impact of trends or events in the general environment can vary across industries.

III. THE COMPETITIVE ENVIRONMENT

Here, we draw upon a well-known analytic tool, Michael Porter's five forces model of industry competition. We introduce this model and discuss examples of each force. We then address the strategic groups concept and its implications for studying rivalry and competition.

A. PORTER'S FIVE FORCES MODEL OF INDUSTRY COMPETITION

EXHIBIT 2.6 illustrates Porter's five forces model of industry competition

When introducing this model, it is useful to show how the model provides insight into an industry's dynamics and expected profit levels. The SUPPLEMENT below provides such an analysis on the paint and allied products industry. The analysis is restricted to the trade sales (i.e., house paint) segment of the industry. The competitive forces are very different for other segments such as the specialized high-tech automobile finishes.

Note: For our purposes of illustrating the "basics" of the "five forces," the analysis has been simplified. We assume buyers to be consumers, although there are, of course, other distinct groups such as hardware stores, and large discounters such as Wal-Mart. Obviously firms' bargaining power vis-à-vis paint manufacturers vary significantly. Similarly, our analysis assumes the industry's products to be commodity products. However, there are exceptions, such as Olympic Stain, that have successfully differentiated their products on the basis of quality.

The Paint and Allied Products (PAP) Industry

An analysis of the Paints and Allied Products industry (SIC 2851), using the five forces model, demonstrates why this industry has traditionally been caught in a price-cost squeeze and is unable to pass on rising raw material costs to its customers.

To illustrate the price-cost squeeze that this industry is facing, consider that between the years 1995 to 2000, the PPI (producer price index — the price for which it sells its output) of the PAP industry increased an average of only 2 percent. The PPI for petroleum refining and related products — a key supplier to this industry — increased at a rate of 6 percent over this same period of time. Hence the price of this key raw material was roughly twice the rate of inflation (about 3 percent); whereas, the PAP industry was lower than the rate of inflation. Thus, the PAP industry has been unable—due to unfavorable industry competitive forces — to pass on cost increases to their suppliers; thus eroding profitability.

Consider the PAP industry in terms of each of Porter's Five Forces:

Threats of Entry: Very High (minimal capital investment needed, little proprietary technology, regional firms can compete in local markets due to high transportation costs, little brand identification of existing competitors)

Buyer Power: Very High (low brand loyalty, relatively little product differentiation, relatively low switching costs)

Supplier Power: High (especially for petroleum derivative raw materials—a key input in industry)

Substitute Products: High (plastics, wood paneling, wallpaper coverings, etc.)

Rivalry: High (competition is based mostly on price competition, because of little brand loyalty and product differentiation; easy entry and exit from the industry gives rise to frequent price wars; little price leadership exhibited by larger firms)

Sources: www.bls.gov (Bureau of Labor Statistics); www.ita.doc.gov (International Trade Administration)

It is useful to point out that there can also be very profitable opportunities to compete in industries that have overall low profits, overall. For example, in the paint industry, Olympic Stain has typically been a very successful and highly-profitable firm because they have found an attractive niche in the market and developed a differentiated product (through product development and advertising). The SUPPLEMENT below provides two examples of how attractive opportunities were exploited in what seemed to be unattractive market segments.

HOW SEEMINGLY UNATTRACTIVE MARKET SEGMENTS CAN LEAD TO BIG OPPORTUNITIES

Paychex, a payroll-processing service company built nearly a billion-dollar business by serving small businesses. Existing firms had ignored these customers because they assumed that such firms could not afford the service. When Paychex's founder, Tom Golisano, failed to convince his bosses at Electronic Accounting Systems that they were missing a great opportunity, he launched a firm that now serves 390,000 U. S. customers — each employing about 14 employees. Paychex's after-tax-return on sales is a stunning 29 percent — equal to Mircosoft's and greater than the margins of the pharmaceutical money machines Amgen and Pfizer.

Also, consider WellPoint Health Network, which suffered $160 million in losses in 1986 (when it was known as Blue Cross of California). At that time, Leonard Schaeffer became CEO and challenged the conventional wisdom that individuals and small firms were money losers. (Clearly, this was a counterintuitive move since the firm was losing $45 million a year insuring 65,000 individuals!) However, by the early 1990s, the health insurer was leading its industry in profitability, and the firm has continued to grow and outperform the rest of its sector even during economic downturns.

Source: Rosenblum, D., Tomlinson, D., & Scott, L. 2003. Bottom-feeding for blockbuster businesses. Harvard Business Review, 81 (3): 52-59.

1. THREAT OF NEW ENTRANTS

After summarizing the major barriers to entry, ask students to provide examples of industries characterized by each of these entry barriers. This may help them to understand what initially may appear to be rather complex ideas.

We discuss the example of ProCD — a firm (producing electronic telephone books) that failed because of low entry barriers.

Teaching Tip: The chapter explains how economies of scale and economies of experience (learning curve) erect significant entry barriers. In the auto industry, U.S. manufacturers such as Ford and G.M. have high economies of scale (being the biggest producers) and all the benefits of learning curve (having been in the business for almost a century). Despite these advantages, foreign auto producers have entered the U.S. market and have increasingly gained market share over the past few decades. Ask the students why this happened? Does this prove that the concepts we discussed are wrong? Or does it point out that additional factors have to be considered? Point out that foreign producers have the benefits of lower labor costs and/or have developed better manufacturing technologies (such as Toyota's lean manufacturing).

2. BARGAINING POWER OF BUYERS

Briefly summarize some of the conditions under which a supplier group may become powerful. It may be interesting how things have changed (if they have) with regard to the power of buyers of talent (i.e., businesses of varying sizes and industries) and suppliers of talent (i.e., business school graduates—either undergraduate or MBA).

3. BARGAINING POWER OF SUPPLIERS

Briefly discuss some of the conditions under which a supplier group may become powerful. The bargaining power of suppliers can be presented as the mirror opposite of the bargaining power of suppliers. For example, the relative sizes and concentrations largely determine the bargaining power of the two parties involved in the transaction.

The section discusses the relative power of the providers of talent — ranging from unskilled labor (low) to highly skilled professionals (high). Especially hard hit will be several unions such as those in declining industries such as steel manufacturing.

STRATEGY SPOTLIGHT 2.7 discusses how a group of catfish farmers formed a cooperative, Delta Pride Catfish, to process their own catfish – an example of forward integration by suppliers.

4. THE THREAT OF SUBSTITUTE PRODUCTS AND SERVICES

Emphasize that the viability of a substitute product depends largely on its relative price-performance trade-off, i.e., more value for the same price or the same value for a lower price. Examples are electronic security systems versus security guards, and the use of steel versus plastic for components in the manufacture of automobiles.

We discuss substitutes and give the example of IBM's use of teleconferencing. Clearly, this technology poses a threat to the airline industry.

The SUPPLEMENT below addresses important substitute products/services that threaten to erode the surplus of the United States Postal Service (USPS). These substitutes are e-mail and online bill paying.

Tough Competitors to the USPS

After operating at a surplus — helped by a booming economy — the quasi-governmental mail agency has plunged as much as $3 billion into the red, its greatest deficit in modern history.

The USPS warned long ago that email and online bill paying threatened its core business. And indeed, a recent slowdown in first-class mail has hit hard, while cheap advertising mail has filled letter carriers' bags. That combination hurts two ways: Revenues fall short of projections while costly deliveries are up. Way up: The USPS must deliver its ever less profitable mix of mail to 2 million added addresses every year. Its workforce has grown with its workload, to more than 900,000 — the second largest U. S. civilian force after Wal-Mart's. Labor costs eat up 76 percent of its revenues, compared to only 56 percent at United Parcel Service and 42 percent at FedEx Corporation.

Source: Lavelle, M. 2001. Why the postman can't deliver profits. U.S. News & World Report. April 9: 46.

5. THE INTENSITY AMONG COMPETITORS IN AN INDUSTRY

After discussing the factors that lead to intense rivalry in an industry, provide an example of an industry in which competition has recently been intense. For example, most students are familiar with the recurring price wars in the U. S. airline industry. Ask them to explain this using the factors discussed (e.g., undifferentiated service, low switching costs, slow industry growth, numerous competitors, etc.) You might point out that this industry was expected to report huge losses in 2001 even before the September 11, 2001 terrorist attack. Beginning in late 2005, the airlines' problems were further aggravated by extremely high fuel costs.

In this section we discuss the intense rivalry between Pfizer's Viagra (impotence treatment product) and a competing product developed by Eli Lilly & Company and Icos—Cialis. This provides an example that intense rivalry can take place on factors other than pricing in an industry that is highly profitable.

The SUPPLEMENT below is Michael Porter's response to a question as to whether or not he would add a "sixth force" if he were developing his framework today.

SHOULD THERE BE A "SIXTH FORCE?" MICHAEL PORTER'S PERSPECTIVE

"There have been two nominees for the sixth force. One is government. After much further work using and teaching the framework, I have reaffirmed my original conclusion that government is not a sixth force because there is no monotonic (direct linear) relationship between the strength and influence of government and profitability of an industry. You can't say that "government is low, industry profitability is high." It all depends on exactly what government does. Also, there are many different parts of government, each with its own distinct impacts. And, how do you assess the consequence of what government does? Well, you look at how it affects the five forces.

"The other, more recent, candidate for a sixth force involves organizations whose products and services are complementary to the primary organization's products and services. Again, there is no monotonic relationship between the extent of complements and profitability. Sometimes having many complements is consistent with high industry profitability, sometimes with low profitability. It has to do with how complements affect the five forces…Clearly, complements have much to do with the size of the pie, but their role in the division of the pie is independent on other factors."

Source: Argyres, N. & McGahan, A. M. 2002. An interview with Michael Porter. Academy of Management Executive. 16 (2): 43-52.

B. USING INDUSTRY ANALYSES: A FEW CAVEATS

This section was written as a "caveat" to address some limitations of Porters five forces model. First is the idea that business is not always a "zero-sum game"— which is an assumption that is implicit in Porter's five forces model. We discuss how companies can collaborate with each other for mutually beneficial outcomes.

The SUPPLEMENT below provides a more detailed example of "win-win" relationships in the supermarket industry.

The benefits of close supplier-buyer relationships

Experts in the supermarket industry believe that seamless partnerships between manufacturers and supermarkets would accelerate the deployment of sophisticated systems such as just-in-time delivery, electronic data interchange, and so-called efficient-consumer-response systems that permit manufacturers to monitor sales in stores and to produce and ship their goods in response to actual customer demand. Such cooperative systems could squeeze $30 billion in excess costs out of the industry by eliminating superfluous inventory, duplicate functions, and various middlemen. Moreover, the results witnessed when manufacturers and supermarket chains do cooperate suggest that both sides could increase sales volume by working together to customize offerings at different stores and for different end users. Cooperation between Kraft Foods and supermarket chains such as Publix Super Markets in Florida and Wegman's Food Markets in upstate New York has generated significant returns for both sides.

Source: Kumar, N. 1996. The power of trust in manufacturer-retailer relationships. Harvard Business Review, 74(6): 95.

The second issue we raise is that the five forces analysis has often been criticized for being a static — rather than a dynamic analysis. Brandenberger and Nalebuff introduced the concept of the value net which we include in Exhibit 2.7.

Transparency XX (Ex. 2.7) The Value Net

The concept of complementors is often considered to be the single most important contribution of value net analysis. Complements typically are products or services that have a potential impact on the value of the firms' own product and services. We provide the examples of complements (software and microprocessors) in the personal computer industry and the video game industry. (As we noted in an earlier supplement, Professor Michael Porter would not add complements to the "five forces" because they don't have a direct linear relationship to industry profitability. However, they clearly can have an impact on an industry's profitability.)

C. INDUSTRY ANALYSIS: A DYNAMIC PERSPECTIVE

In this section, we draw on Professor Anita McGahan's work on the analysis of industry evolution. Her analysis is based on the identification of the core activities and core assets of an industry and the threats that they face. Her framework provides a two-by-two typology to form four possible types of evolutionary trajectories — radical change, creative change, intermediating change, and progressive change. It is shown in Exhibit 2.8.

Transparency XX (Ex. 2.8) Four Evolutionary Trajectories…

In addition to the implications discussed in the text, it may be helpful to address some of the implications for diversification. These are included in the SUPPLEMENT below:

A DYNAMIC PERSPECTIVE OF INDUSTRY ANALYSIS: IMPLICATIONS FOR DIVERSIFICATION

In the paragraph below, Professor McGahan addresses some of the implications that her approach has for diversification:

Some of the most exciting opportunities associated with industry evolution relate to diversification across industries. By participating in more than one industry on a progressive trajectory, Wal-Mart has enhanced the effects of its powerful distribution systems. And with its acquisition of Kinko's, FedEx has diversified in response to radical change. Some of the major challenges of diversification have to do with sharing core activities and core assets across divisions on different trajectories, and developing clear lines of authority for resolving disputes between divisions as their industries create different investment requirements. It is virtually impossible to diversify profitably without understanding the differences in the trajectories and phases of industry change.

Source: McGahan, A. M. 2004. How industries change. Harvard Business Review. 82 (10): 94.

Teaching Tip: Even when industry analysis shows that an industry is unattractive, there are a few firms that seem to be able to earn high returns. For example, Southwest Airlines has been consistently profitable in an otherwise unattractive industry over the past several years. Does this mean that industry analysis is misleading? You may point out that industry analysis is useful to predict an industry's average profitability, but not necessarily, a single firm's profitability. This is a good opportunity to introduce the role of the strategist in outperforming industry norms.

C. STRATEGIC GROUPS WITHIN INDUSTRIES

Most of your students are probably very interested in the automobile industry. EXHIBIT 2.9 provides a strategic grouping of the worldwide automobile industry. It is rather clear from the discussion in the text that the intensity of competition within strategic groups is much more intense than competition across groups.

Point out four benefits of strategic groups as an analytical tool:

1. Strategic groupings help a firm identify mobility barriers that protect a group from attacks by other groups.

2. It helps a firm to identify groups whose competitive position may be marginal or tenuous.

3. It helps chart the future directions of firms' strategies.

4. It helps in thinking through the implications of each industry trend for the strategic group as a whole.

It may be interesting to ask the students what dynamics they envision in the automobile industry, i.e., how membership in strategic groups may change and if new strategic groups may emerge.

q What are some of the strategic groups in other industries with which you may be familiar? What are the implications? (e.g., retailing)

IV. SUMMARY

Managers must analyze the external environment to minimize or eliminate threats and exploit opportunities. This involves a continuous process of environmental scanning and monitoring as well as obtaining competitive intelligence on present and potential rivals. These activities provide valuable inputs for developing forecasts. In addition, many firms use scenario planning to anticipate and respond to volatile and disruptive environmental changes.

We identified two types of environment: the general environment and the competitive environment. The six segments of the general environment are demographic, sociocultural, political/legal, technological, economic, and global. Trends and events occurring in these segments, such as the aging of the population, higher percentages of women in the workplace, governmental legislation, and increasing (or decreasing) interest rates, can have a dramatic effect on your firm. A given trend may have a positive impact on some industries and a negative or neutral impact, or none at all on others.

The competitive environment consists of industry-related factors and has a more direct impact than the general environment. Porter's five forces model of industry analysis includes the threat of new entrants, buyer power, supplier power, threat of substitutes, and rivalry among competitors. The intensity of these factors determines, in large part, the average expected level of profitability in an industry. A sound awareness of such factors, both individually and in combination, is beneficial not only for deciding what industries to enter but also for assessing how a firm can improve its competitive position. We also addressed some of the limitations of Porter's five forces model, including its "zero-sum perspective" and its omission of the key role of complements. Although we discussed the general environment and competitive environment in separate sections, they are quite interdependent. A given environmental trend or event, such as changes in the ethnic composition of a population or a technological innovation, typically has a much greater impact on some industries than on others.

The concept of strategic groups is also very important to the external environment of a firm. No two organizations are completely different nor are they exactly the same. The question is how to group firms in an industry on the basis of similarities in their resources and strategies. The strategic groups concept is valuable for determining mobility barriers across groups, identifying groups with marginal competitive positions, charting the future directions of firm strategies, and assessing the implications of industry trends for the strategic group as a whole.

PowerPoint:Creating Competitive Advantages

2007-05-03T06:06:00.001-07:00