TEST THE STRATEGY-ENVIRONMENT LINKAGE

We now turn to the task of testing how well a strategic proposal addresses the oppor-tunities, challenges, and timing requirements of the environment. To help organize this process we have classified environmental forces into four basic categories:

demand, supply, competition, and government. The elements of this model are por-trayed in Figure 5.2. In the following sections we will review each of the environment

Figure 5.2 Testing the Strategy-Environment Linkage Business Environment Analysis Model (BEAM)

• Regulation of structure and conduct

• Regulation of structure and conduct

categories and present several concepts that will help you to pursue your analysis.

This model is not intended to supplant the models previously presented. Rather it is intended as a starting point to conduct your environment analysis. It is helpful to mentally review the other models to assess whether they might provide some insight into the situation at hand.

The four components we identify are quite consistent with the models presented in Chapter 4. As noted in the discussion of the value chain and Porter’s Five Forces, understanding supply, demand, and competition is critical. We add government to the list since in many economies the regulatory environment has a direct impact on the industry.

Simply examining the political factors that affect the industry, as in the PEST model, does not adequately capture the microprocesses of industry analysis. In the following sections we develop each component of the model in further detail.

As the process of questioning and testing proceeds, you will develop a better under-standing of environment conditions and an accumulating evaluation of the strategy-environment fit. These may lead to an early conclusion that the strategic proposal is inadequate, in which case you should recycle the analysis, as indicated in Figure 5.1, to develop a better proposal that incorporates your findings.

Demand

The test of the linkage of your proposal and demand is whether it anticipates opportuni-ties and creates advantages in the way that it addresses customer requirements and trends in the market. Is the strategy aimed at growing market segments? Does the strategy tap into new customer needs? In this process it is particularly important for you to gauge the degree to which a strategic proposal incorporates (1) the needs and preferences of current and potential customers; (2) the scale and timing of market development; and (3) the bargaining power of customers.

Needs and Preferences It is surprising and discomforting to observe the degree to which companies will sometimes commit themselves to strategies without pinning down the fundamentals of anticipated demand. The literature on new product development is full of warnings on this account and of examples of setbacks in companies that ought to have known better, such as Microsoft with Microsoft Bob and IBM with OS/ 2.² The lesson is that you simply should not feel comfortable unless you understand the links between your strategy and your intended customers.

Consider the strategic change that drove a turnaround at the Blockbuster Video chain. After several years of rapid growth, Blockbuster’s sales and profitability faltered in the mid-90s. Some analysts explained the slump by pointing to the increasing popu-larity of new technologies such as video on demand, but the real source of the problem was utterly prosaic. Customer service levels at Blockbuster had been sacrificed to the point where one in five shoppers went home empty-handed or went away without the exact video that they wanted.³ How could a company like Blockbuster underestimate the importance of having available the videos that customers wanted when they visited

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the store? It was partially out of arrogance, no doubt, but beneath this there was a strat-egy and profit model under which Blockbuster purchased tapes outright from the movie studios, making a fully adequate inventory a very expensive proposition. As a result, now that dissatisfaction was showing up in deteriorating performance, it had become common-place at Blockbuster to manage dissatisfaction rather than to deal with the basic customer service issue. The habits of the past were so ingrained, moreover, that it took a new and forceful CEO to highlight the importance of customer service and to work out a solu-tion to the problem. This was not easy; to support new higher service levels, Blockbuster had to overhaul its profit model completely. It did so by negotiating a new deal with the studios under which revenue-sharing arrangements were used to reduce substantially the fixed purchase cost of tapes. This made adequate inventories feasible, at the penalty, of course, of unit profit margins. The result was an immediate improvement in business.

Then Blockbuster once again missed a change in customer preferences as customers moved towards digital downloads such as NetFlix and low cost rentals at kiosks such as Redbox. Blockbuster’s large brick and mortar operation became an anchor on its business, In 2010 it filed for bankruptcy protection in the US to re-invent itself to focus on digital download offerings.

The problem in such instances is not that managers are unaware of the importance of customer needs and preferences. It is that other priorities get in the way. Blockbuster is a case in point. Another classic example is the belated recognition by Levi Strauss &

Co. that its basic North American blue jeans business was in trouble. Changing demo-graphics and tastes had been leaving Levi’s traditionally dominant jeans behind and creating opportunities for new competitors such as Tommy Hilfiger, Calvin Klein, The Gap, JNCO, and others. But Levi was slow to take note, in good part because its design, marketing, and merchandising units operated quite autonomously, to the point, even, of working from separate office buildings.⁴ Structure and politics were getting in the way of timely focus and market response. Levi ultimately moved to streamline its organization and get on with a push into new fashion concepts.

A major benefit of periodic strategic reviews is that they give you the opportunity to stand back and make sure that customer needs and preferences are being effectively addressed by your organization.

Scale and Timing of Market Development The goals of a strategic proposal set out performance expectations. A critical test of these promises is whether the revenue projections are reasonably consistent with the anticipated scale and pace of market devel-opment. The uncertainties that you will need to address in this test will vary across the product market life cycle. In the early stages of the cycle, the major concern is timing:

When and at what rate will the market develop? Later, with growth established, the key question is one of ultimate potential: Where is the ceiling? Even later, in maturity, the worry is vulnerability: How will substitutes affect future demand?

Timing is thus a particularly crucial issue in many strategic proposals. The questions that you will face are often not so much whether a market exists, but how fast it will develop and how long it will last. Think of the timing question facing Cinram International in

2003 as it considered the acquisition of AOL Time Warner’s DVD and CD manufacturing operations. The $1 billion deal would make Cinram the world’s largest DVD and CD pro-ducer. CD demand was in decline and manufacturing contracts were becoming increasingly competitive. DVD was on the rise, but to what heights and for how long before capacity increases squeezed pricing, and new formats such as video on demand and personal DVD recorders cut into the market? While initially the purchase contributed to Cinram’s bot-tom line, by 2007 the DVD industry had matured and Cinram took a $314m write down primarily related to this business. It took a further write down in 2010 when Warner House Entertainment cancelled its agreement to purchase DVDs from Cinram.

Customer Bargaining Power In Porter’s Five Forces Model, the thrust of the anal-ysis focuses on the bargaining power of the buyer. Porter contends that the higher the bargaining power of the buyer, the lower the industry attractiveness. However, it is help-ful to pursue the issue of bargaining power beyond the issue of industry attractiveness. In consumer goods and services, customer buying power is an aggregate phenomenon, sum-marizing the collective ability and willingness of buyers to influence prices and volumes.

A significant question in the analysis of the fit of a strategy with demand forces is whether the strategy properly anticipates the timing and degree of change in buying power that will occur as a result of industry disruptions, such as the advent of new technology. The internet, for example, is fundamentally changing the role of store-based retailers by pro-viding consumers with a competitive place to make a purchase, or, at a minimum, with powerful tools to “pre-shop” for price and product features before visiting a store.

In industrial goods, demand is shaped more directly by the bargaining power of indi-vidual customers. For example, the automakers usually have a high degree of bargaining power because (1) they buy goods in quantities that represent important volumes to their suppliers; (2) they have a choice of suppliers from which to buy; and (3) they have the capability, should they choose to exercise it, of integrating backward into production for themselves. As a consequence, the supplier firms in the industry are frequently caught in tough bargaining situations in which their customers have a distinct advantage. To coun-ter such circumstances, suppliers build strategies to link their customers into their unique capabilities and to spread the risk of individual projects by maintaining a broad portfolio of contracts and customers.

There are, of course, many aspects of demand that you will need to consider as you review the prospects of your strategy. The key is to stay on track and stick to fundamental issues such as we have illustrated with the foregoing examples.

Supply

A further test of the linkage between your strategic ideas and the environment lies in the potential for advantage and disadvantage in supply conditions and trends, as Porter iden-tified in the Five Forces Model. Consider, for example, the possibilities in the matching or mismatching of strategy with (1) technology, (2) supplier competence and bargaining power, and (3) competition for raw materials and people.

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Technology If your strategy anticipates developments in technology, it might give you a head start on your rivals and an opportunity for industry leadership. The pioneer internet retailer Amazon.com, for example, took early advantage of the new possibilities in electronic commerce to challenge the conventional booksellers Barnes & Noble Inc.

and Borders Group Inc. Then, as the internet bubble burst, Amazon was widely thought to be heading for the scrap heap. Not so. With a singular attention to the possibilities of technology in supply and delivery as well as in internet selling, Amazon.com bounced back as a dominant and increasingly broader-based retailer. As CEO Jeff Bezos says, “The three most important things to us are technology, technology, technology.”⁵

On the other hand, if your strategies fail to anticipate and respond to technical change you might quickly become the laggard in the industry. Research in Motion, for example, suffered serious consequences to its corporate performance and reputation when it underestimated the speed of technological change in smartphones by companies such as Apple, LG and HTC, and overestimated the protection that its traditional enterprise business would offer. As in the estimation of demand forces, the issue with technology is often one of timing; it is critical that you keep your strategic reviews up to date on the pace of new developments.

Supplier Competence and Bargaining Power Another area of potential stra-tegic advantage or constraint that you need to consider is in the linkage of strategies to the competence and bargaining power of suppliers. The issue of supplier power is a primary focus in Porter’s model. However, as in the case of the bargaining power of the buyer, it is helpful to look beyond industry attractiveness to assess the implications of supplier power.

The ability of strategies to create marketplace advantages, for example, will often depend on high levels of supplier competence. Retailers such as Home Depot and Canadian Tire are a case in point: their ability to deliver superior prices and in-stock reliability relies heavily on their programs to develop supplier competence, to the point of virtual integra-tion through electronic data interchange. Their considerable bargaining power relative to most suppliers helps expedite the process of development and integration. When the reverse is true, however, supplier capabilities and bargaining power can be a significant problem. Wal-Mart’s expansion in Brazil, Argentina, and other developing countries, for example, has been delayed by both the reluctance and the limited competence of local suppliers, and their superior bargaining power relative to the Wal-Mart start-up business.

If you face powerful suppliers that can influence the cost, quality, and delivery of essential inputs, you need to account for this in the development of your strategic pro-posal. Fabricators of steel products, for example, try to reduce their reliance on powerful raw steel suppliers by seeking product markets where they can incorporate value-added services in design and installation, and reduce their reliance on raw steel supplies.

Competition for Raw Materials and People In many industries, the most sig-nificant strategic opportunities lie in the ability to achieve an advantage in raw materials and people. You will need to be particularly careful in these instances to check that your strategic proposals have fully considered these possibilities. In resources, for example, the

quantity and relative cost of gas, oil, timber rights, mineral deposits, and so forth go a long way towards defining the position and future possibilities for the companies in their respective industries. The critical strategic test in these industries lies in how well the businesses develop and sustain their raw materials positions. Consider the fall over the last few years in the cost of production of natural gas with development of shale gas pro-duction techniques in North America. The cheaper recovery costs and widespread avail-ability of shale gas threaten to undermine the viavail-ability of conventional natural gas plays.

In response to these changes, Exxon Mobil acquired XTO Energy and thus provided itself access to significant unconventional natural gas reserves along with the technology and knowledge that XTO brought on exploiting unconventional natural gas fields.

In skill- and service-intensive industries, businesses vie to become the “best company to work for.” W.L. Gore, for example, focuses on innovation (Gore-Tex, vascular graft materials, guitar strings, etc.) and attributes much of its success to empowerment policies such as letting employees find out what they want to do. New project champions must recruit “volunteers.” As one such champion said with respect to his project, “If you can’t find enough people to work on it, maybe it’s not a good idea.”⁶ In the service-intensive airline industry, Southwest Airlines in the United States and WestJet Airlines in Canada translate their capacity to hire flexible and energetic people into customer service advan-tages over their traditional airline competitors.

Competition

The test of the linkage of a strategic proposal and competition is in whether it pur-sues competitive opportunities and offsets competitive challenges and vulnerabilities.

Consider, for example, the development and appraisal of a strategy relative to (1) aggre-gate competitive conditions and their impact on market attractiveness, and (2) the spe-cific strategies of individual competitors.

Aggregate Competitive Conditions You will need to check product market entry strategies, in particular, against an assessment of the attractiveness of the market as determined by aggregate competitive conditions. In this process, Porter’s model provides a useful vehicle to gauge rivalry and the resulting attractiveness of industries and market segments.⁷

Consider the industry-level opportunities and obstacles faced by a privately held manufacturer of plastic drainage products. The company’s early growth had been based on an innovative application of extrusion technology to the fabrication of corrugated plastic pipe for agricultural and industrial drainage. In many applications, the new plastic pipe provided significant advantages in cost and ease of installation over existing clay, steel, and concrete products. After a very profitable ten-year period, however, a number of changes in the industry were squeezing growth and profitability. Product and process technologies for existing applications had matured and were readily available to com-petitors and new entrants. Large installation contractors were bargaining successfully for very significant price and delivery concessions. Resin suppliers had consolidated and

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accumulated significant bargaining power relative to users. Substitute product produc-ers in steel and concrete had redesigned their product lines to compete vigorously with the plastic contender. Together these forces were creating an unattractive market for the industry. The company’s response to such a challenging environment, after an appreciable delay in recognizing what was happening, was to shift its product market focus to very large diameter applications that had not been developed because of technical obstacles, and to invest heavily in a risky process development program. As it turned out, the devel-opment efforts were successful. The resulting proprietary technology allowed the company to repeat its earlier success, only now in a new and, for a time at least, more attractive industry segment.

Individual Competitor Strategies In many markets competition boils down to a handful of readily identifiable competitors. In these situations it is imperative for you to look at the competitors individually, study their strategies, and determine the potential impacts on your strategic intentions. More specifically, you should be trying to determine (1) how capable each competitor is, and how steadfast it will be in pursuing its strate-gic course; (2) how your stratestrate-gic proposal might affect the competitor’s prospects; and (3) how motivated and capable each competitor is to react to your strategic initiative, and how it might go about doing so. These results, in turn, will condition your expectations for your own strategic proposal.

At times, the strategies of close competitors are reasonably easy to figure out.

Monsanto has long been developing its capabilities in the growing crop biotechnology industry. When rival Dupont spent nearly $3 billion on acquisitions and partnerships in the industry, its underlying strategy was quite apparent. Dupont was intent on weav-ing together a formidable competitive position by integratweav-ing the core activities of crop biotechnology, from basic science to farm distribution. Monsanto had little choice but to respond in kind if it intended to be a long-run contender in the industry. Accordingly, a year later Monsanto was in the process of bolstering its position through over $5 billion in acquisitions including DeKalb Genetics Corp., Delta and Pine Land, and Cargill Inc.’s international seed operations.

At other times it is more difficult to pin down what your competitors are up to.

Consider the consternation at Coke when PepsiCo announced in 2009 its intention

Consider the consternation at Coke when PepsiCo announced in 2009 its intention