Chap - 5 Srategic Capability

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(1)chapter 5. Strategic capability Contents Introduction Examination context Topic List 1. Resources, competences and capabilities. 2. The work of Hamel and Prahalad. 3. Transforming resources: the value chain. 4. Networks, relationships and architecture. 5. The product-service portfolio. Summary and Self-test Answers to Self-test Answers to Interactive questions. © The Institute of Chartered Accountants in England and Wales, March 2009. 151.

(2) Business strategy. Introduction. Learning objectives. Tick off. In the context of a business scenario: . Identify the factors which may affect a businesses ability to achieve its chosen strategy. . Understand the concept of a 'strategic asset'. . Apply the concept of a product portfolio. . Explain the nature of capabilities and competences, and understand the concept of 'dynamic capability'. . Carry out a resource audit using the Ms model and identify limiting factors. . Understand the value chain model and apply it to scenarios and industries. . Describe the role of networks, including supply chain management, in the development of a business's strategic capability. The specific syllabus reference for this chapter is 1d.. Practical significance It is conventional for accountants to consider 'resources' and 'assets' purely in financial reporting terms. We know that non-current assets (tangible and intangible in some cases) sit on the balance sheet and there are financial reporting standards as to how they should be accounted for. However, what makes a business successful might often be things that are not so readily accessible for financial reporting: the legacy of 'early mover advantages' in building up a strategic position; the company's reputation; the quality of a company's relationships and its ability to exploit them; the ability of its management to innovate; the ability of the company to cope with the unexpected; the ability of the company to learn. Intangible assets, such as trade marks, might also sit on the balance sheet. A company's brands, however, which for business decision making purposes, if not always for financial reporting, certainly have a value. The practical significance therefore lies in your ability to see beyond the numbers to the underlying realities. For example, if you are asked to comment on a forecast, or be part of a team that does a 'due diligence' audit, these are business realities that you must be attuned do. Moreover, if you aspire to be, say, a Finance Director (avoiding a lot of the number crunching) you need to understand beyond the numbers.. Stop and think Research reveals that much of the collective market capitalisation of the top 100 firms cannot be related to the sum of their net asset values. In the case of an acquisition this would be called 'goodwill', but what does it consist of? Adding up the assets values of a firm is only one step in understanding the value of a business. What else should we be considering?. Working context The internal capabilities of the business might be relevant to an audit opinion on going concern, part of a due diligence investigation, value audits and so on. It might also alert you to critical business risks. 152. © The Institute of Chartered Accountants in England and Wales, March 2009.

(3) STRATEGIC CAPABILITY. 5. Syllabus links This chapter contains material that will almost entirely new to you. In your Business and Finance syllabus you covered organisational structures at a basic level. Some elements of organisational structure will be touched upon here.. © The Institute of Chartered Accountants in England and Wales, March 2009. 153.

(4) Business strategy. Examination context. Exam requirement This chapter includes key principles of strategic capability, core competences and resource based strategy. Questions are likely to focus on the linkages between elements and the manner in which, when used together, they can facilitate strategy and leverage competitive advantage.. 154. © The Institute of Chartered Accountants in England and Wales, March 2009.

(5) STRATEGIC CAPABILITY. 5. 1 Resources, competences and capability Section overview. 1.1. . Firms own many assets. Some of these assets will be sources of superior earnings in the future for the business and are called strategic assets.. . A resource audit catalogues the assets using handy checklists such as 9Ms etc. However this is not sufficient to understanding whether they are strategic assets.. . Benchmarking compares the use of assets across the firm or across the industry and indicates where they might be used better or where they are already a source of superior performance.. The focus of strategic thinking Strategies are focussed on products and markets, and that these are the source of ideas. Having the resources to make these products and to serve these markets is essential.. Definition Resource-based approach views the resources of the organisation not just as facilitators to gain competitive advantage from product-market strategies but as sources of strategic advantage in themselves.. 1.2. Critical success factors Definition Critical success factors (CSFs): 'Those product features that are particularly valued by a group of customers, and, therefore, where the organisation must excel to outperform the competition' (Johnson, Scholes & Whittington).. CSFs differ from one market segment to another, e.g. in some price may be key, in others quality, in others delivery, etc. CSFs concern not only the resources of the business but also the competitive environment in which it operates, discussed in Chapters 3 and 4, i.e. how will the business achieve a sustainable competitive advantage (SCA) over its competitors? The following diagram shows the relationship between the different resources of an entity and the activities and processes which transform those resources into outputs to create added value. It also shows the way in which entities can generate a sustainable competitive advantage over their competitors by their unique control/ownership of particular core competencies in these processes and activities.. © The Institute of Chartered Accountants in England and Wales, March 2009. 155.

(6) Business strategy CSFs derived form Internal analysis. Resources (Ms). Competences. Achieve/ meet Unique. Threshold. Threshold. Core. Value chain Benchmark/ KPIs. Kay’s 3 sources. Sustainable competitive advantage. Resources No SCA. SCA. 1.3. Threshold resource. Unique resource. Competences. Threshold competence. Core competence. Threshold resources. The basic resources needed by all firms in the market.. Unique resources. Those resources which give the firm a sustainable competitive advantage over its competitors, enabling it to meet the CSFs. They are resources which are better than those of the competition and difficult to replicate.. Threshold competencies. The activities and processes involved in using and linking the firm's resources necessary to stay in business.. Core competencies. The critical activities and processes which enable the firm to meet the CSFs and therefore achieve a sustainable competitive advantage. The core competencies must be better than those of competitors and difficult to replicate.. Core competences – Kay's three sources Kay (1993) argues that there are three distinct capabilities a company can develop that add value. These capabilities or core competences can originate from three sources. Competitive architecture This is the network of relationships within and around a business. There are three divisions as described below.. 156. © The Institute of Chartered Accountants in England and Wales, March 2009.

(7) STRATEGIC CAPABILITY.   . 5. Internal architecture – relationships with employees External architecture – relationships with suppliers, intermediaries and customers Network architecture – relationships between collaborating businesses.. The knowledge, routines and information exchanges created by these relationships (particularly those which are long term) can produce core competences which other businesses cannot replicate. Reputation This is the reason why customers come back, investors invest, potential employees apply for jobs and suppliers supply. Reputations (at least good ones) are not developed overnight – they can take years. Once a business has a good reputation it provides a core competence that rivals cannot match. Examples (may) include BMW and Virgin Atlantic (reputation for quality and service). Innovative ability This is the ability to develop new products and services and maintain a competitive advantage. Organisation structure, culture, routines, etc. and collaboration between employees, customers and suppliers (i.e. the architectures discussed above) influence the ability of a business to innovate. Sony has consistently been innovative.. 1.4. The resource audit In reviewing strategic capability, a first step is to conduct a resource audit. This covers physical resources, intangibles, human resources, technological resources and financial resources.. 1.4.1. Physical resources These include resources owned by the firm and resources to which the firm has access, for example in a supply chain or network.. 1.4.2. . Physical assets should be audited reviewing how cost-effectively they are used. A measure of capital productivity is profit per unit of capital.. . Inventories and working capital are also resources, but they have to be financed. The focus of just-intime approaches to inventory management and production (JIT) has been to reduce the need to finance working capital.. . Raw materials. Is the firm vulnerable to sudden changes in prices – are there long-term supply contracts or hedging instruments which can overcome this?. . Finally, are physical resources constraints on strategic activity (i.e. limiting factors)?. Intangibles and other resources Brands and other reputational assets are resources created by a firm through the process of transforming inputs into outputs. Patents and other aspects of intellectual property are also intangibles. These also include customer relationships and relationships with other key stakeholders such as media, and governments.. 1.4.3. Human resources and labour markets Human resources comprise the productive services people offer to the organisation. Human resources more generally can include the following. . Headcount: Does the firm have enough people to do the task or can the work be done more productively with fewer?. . Skills base available to the firm: measured though qualification and training, and the social and psychological aptitudes linking the technical skills to performance.. . Culture: The emotional and motivational climate of an organisation is critical to its success particularly in industries where personal service is essential to the 'experience' the company is offering.. © The Institute of Chartered Accountants in England and Wales, March 2009. 157.

(8) Business strategy . Knowledge: A firm's knowledge is partly embedded in people, what they do and how they are organised.. . Workforce structure and organisation structure. . The right mix of labour and capital There is a trade off, in some respects, between using people and using equipment to save money or to increase efficiency. For example, reducing the costs of a call centre can be achieved by: – –. Voice activated software and voice recognition software to process simple transactions Outsourcing it 'off-shore' to a country where labour costs are lower.. The choice will depend on the potential cost savings and benefits and perhaps customer resistance and the firm's attitudes to reputational risk if it cannot achieve its level of service. . Service levels Whilst some services can be automated, others cannot – customer service staff are often those who encounter the most moments of truth with the customer. In a service-led economy, the quality of human interaction is an important element of customer satisfaction. To provide good service, those at the customer interface must be supported by a management infrastructure of robust information systems and good training and supervision.. . Human capital and knowledge industries Knowledge-based industries require the creation and use of intellectual property. The skills and mindset necessary for this may often rely on the education and cultures of the country of operation.. . Workforce structure The right balance between full-time and part-time staff can provide a variable resource that can be accessed when necessary to achieve flexibility. The flexibility of employment contracts, such as covering other tasks and locations, can add to this.. 1.4.4. Technological resources Technology is a 'resource' in many different ways as was discussed in Chapter 3. Here we focus on two further aspects. . The organisation's capability to manage technology projects, especially IT projects. The costs and complexities of such projects means there is potential for failure (and success) on a huge scale. Implementing a successful technology solution enabled low cost carriers such as easyJet and Ryanair to reduce their cost structures and to open low cost air travel to many people. Alternatively, failed technology implementations can drive away customers.. . 1.4.5. The impacts of the technology itself: –. Enable the development of a new product or service generated by technology. –. Have a disruptive impact on an industry (e.g. digital music downloads threaten to overturn the traditional music industry business model). –. Enable increase in productivity. –. Engender additional risks. Financial resources The business will need finance for any expansion. One aspect of a resource audit would be to simply look at the different sources of finance available to the firm – internal generation, loans, equity, credit etc. However, it should be noted that each will come with strings attached such as ceding control to other stakeholders, unavoidable interest payments in the future, the need to keep the investment markets informed. Management may prefer to invest from retained profits as there is not the management time (or scrutiny) involved in getting outside parties to invest more.. 158. © The Institute of Chartered Accountants in England and Wales, March 2009.

(9) STRATEGIC CAPABILITY. 1.4.6. 5. The need for integration Resources considered on their own are inert. Resources are of no value unless they are organised into systems, and so a resource audit should go on to consider how well or how badly resources have been utilised, and whether the organisation's systems are effective and efficient.. 1.5. Resource. Utilisation. Technical resources. For example, processes for new product development, ability to serve customers efficiently.. Managerial skills. An effective management is a key organisation resource in planning activities, controlling the organisation and motivating staff.. Organisation. Organisation structure is critical. For example product or brand divisionalisation or brand management should facilitate communication and decision-making, at the level of the brand.. Information and knowledge systems. These have a strategic role.. A checklist of resources The 9Ms model summarises the resources and sources of competences to be evaluated. The audit should be comprehensive, but it is useful to identify the unique resources which underlie the firm's sustainable competitive advantage (i.e. what sets it apart from other organisations) as opposed to those that are necessary (i.e. threshold) but do not form the basis of sustainable competitive advantage. Men and women: Assessment of the number of men, skills (production, marketing e-commerce, etc), motivation, adaptability, etc. Machines: Number, productive capacity, age, condition, location, etc. Appropriate technological and applications infrastructure for e-commerce, etc. Money: Sources, uses, cash flow forecasts, relationship with shareholders, bankers, etc. Materials: Supplier reliability, flexibility, costs, distribution systems, etc. Markets: Market status, position and market share, brand image, customer loyalty, customer goodwill, distribution systems, etc. Management: Quality, skills, ability of senior management. One key management skill is that of good Corporate Governance and managing risk. (See Chapter 8 for further discussion.) Methods: Activities and processes used, outsourcing, capital or labour intensive production methods, etc. Management information systems: Quality, timeliness, etc (see Chapter 13 for further discussion). Make up: Structure, culture, etc.. 1.6. Limiting factors Definition Limiting factor: A factor which at any time, or over a period, may limit the activity of an entity, often occurring where there is shortage or difficulty of availability.. © The Institute of Chartered Accountants in England and Wales, March 2009. 159.

(10) Business strategy In the long-term, the company may wish to: . Reduce the shortfall by obtaining more of the resource. . Economise on use by reconsidering the activities consuming the resource, e.g. redesign a product to use less machine time.. Worked example: Easing limiting factors in banks Banks have shifted their business from reliance on providing accounts for money transmission and loans to a wider portfolio of products including pensions, home loans, credit cards, and insurances. This presented problems because the floor space of banks is limited, as are staff numbers and staff accommodation. The banks responded to these limiting factors by:. 1.7. . Increasing the number of Automated Teller Machines (ATMs) which dispense cash and account balances but also can be used to make deposits and pay bills.. . The provision of telephone and on-line banking services to reduce the volume of transactions taking place in the bank branches.. . Reducing the number of cashier places to make room for front-office cubicles housing financial advisers. The resulting queues encouraged customers to use the ATMs and online services.. . Recruitment of staff predominantly to sell financial service products, accompanied by use of distance learning materials to assist them in passing the requisite regulatory exams.. Benchmarking competences Once a business has identified its CSFs and core competences it must identify performance standards which need to be achieved to outperform rivals and achieve SCA. These standards are sometimes called key performance indicators (KPIs). One way of setting KPIs is to use benchmarking. Benchmarking is defined by the Chartered Institute of Management Accountants (CIMA) as: 'The establishment, through data gathering, of targets and comparators, through whose use relative levels of performance (and particularly areas of underperformance) can be identified. By the adoption of identified best practices it is hoped that performance will improve.' To ensure a balanced and comprehensive range of performance measures are set, the Balanced Scorecard can be used. Purposes of benchmarking Benchmarking encourages improvement and change in order to achieve strategic competitive advantage over competitors, or at least to reduce costs and streamline operations.. Worked example: Benchmarking at Motorola Best practice benchmarking (BPB) concentrates on manufacturing technology. At Motorola's semiconductor plant in East Kilbride, BPB concentrates on manufacturing technology. Typical areas it has recently benchmarked are:. 160. . Yield and product characteristics for a new MOS 9 silicon wafer, against Toshiba, under a technology transfer agreement. . General wafer fabrication technology: all Motorola plants exchange benchmarking information on cycle time, scrap, yield, productivity and other key measurements. Having identified best performance, the relevant operations managers meet quarterly around the world to pass on how they do it. . Automated assembly performance: this is benchmarked weekly against its Japanese Motorola counterpart, which in turn benchmarks against a Japanese subcontractor. © The Institute of Chartered Accountants in England and Wales, March 2009.

(11) STRATEGIC CAPABILITY. . Warehouse performance: in particular cycle time, quality, productivity and space use against other Motorola installations. . Purchasing performance: both against Motorola companies and friendly companies outside the group. . Salary and benefits packages, through a Motorola-initiated exchange of data with other Scottish manufacturing companies.. 5. Source: DTI Best Practice Benchmarking website. Bases for benchmarking Internal benchmarking . Historical comparison looks at performance over time to ascertain trends/significant changes, etc. but the danger is that performance against competitors is ignored.. . Branch comparisons within the same organisation may help to identify best practice which can be implemented in all branches. Again, the danger is ignoring competitors.. Competitive benchmarking This involves comparing performance with other firms in the same industry or sector. This may involve the use of league tables (e.g. schools, hospitals, universities). The problem with industry norm comparisons is that the whole domestic industry may be performing badly (so international comparisons are better) or the whole international industry is losing out to other industries (so a wider perspective is needed – see below). Activity (or best in class) benchmarking Comparisons are made with best practice in whatever industry can be found. British Airways improved its aircraft maintenance, refuelling, turnaround, etc. by studying Formula One motor-racing pit teams. Generic benchmarking Benchmarking against a conceptually similar process. Again, Formula One was used by car manufacturers to help reduce changeover times on production lines. (Return to the diagram on page 158 to see how resources and competences are related to SCA and CSFs.). Interactive question 1: Car seats. [Difficulty level: Exam standard]. Y Ltd manufactures car seats for children. Y's home country, Z land, has extensive legislation on car safety for many years and child seats are compulsory. The company was formed 10 years ago by an entrepreneur who had previously worked as a technical consultant for an industrial foam company. Despite strong competition, Y Ltd has succeeded largely by careful marketing. The car seats come in a range of sizes and there are a variety of options from fully integrated seats for very young babies to booster seats for older children. The company's main customer is an accessory manufacturer with a major presence in Y Ltd's home market. It buys the car seats from Y Ltd and sells them under its own brand as 'safety approved'. It advertises the car seats in accessory brochures and on its website. The company's second major customer is a large superstore in the home country which specialises in children's clothing and accessories such as prams and pushchairs. The remaining sales are to a varied mix of large and small mainly independent car accessory retailers. The car seats have historically all been produced on a single site in the north of the home country. The Managing Director uses his connections to source the foam padding from several suppliers with a commitment to achieving the lowest price but complying with safety standards and expectations. Z land has sophisticated economy with efficient capital markets; JIT logistics are common in all forms of manufacturing. The company is considering possible methods of expansion and is currently considering exports to neighbouring countries.. © The Institute of Chartered Accountants in England and Wales, March 2009. 161.

(12) Business strategy Requirements (a). Explain how conditions in Z land could give Y Ltd a competitive advantage when it starts its export operations.. (b) The Managing Director of Y Ltd is constantly trying to improve the productivity and quality of his manufacturing operations and is considering a programme of benchmarking. Explain why a benchmarking programme would help Y Ltd and suggest how it might be carried out. See Answer at the end of this chapter.. 2 The work of Hamel and Prahalad Section overview. 2.1. . Hamel and Prahalad belong to the resource-based school of strategy.. . They identify a series if strategic architectures which can form the source of competitive advantage (or distinctive competence).. . Beyond this they accord a significant role to the management team, and in particular the ability of management to create a strategic architecture through the application of strategic thinking.. Recap of the resource-based view of strategy Chapter 1 contained an introduction to the resource-based view of strategy as an alternative to the positioning view of strategy. It claims that rather than focusing on products, markets, and competitive positioning approaches, the focus of the strategist should be on resources and competences. Such a combination of resources and competences takes years to develop and can be hard to copy.. 2.2. Strategic architecture: competences and the future Hamel and Prahalad (1994) identify strategic architecture as one of several 'architectures' a company has. 1. Information architecture includes hardware, software and informal communication patterns.. 2. Social architecture includes generally accepted standards of behaviour and hierarchy of values.. 3. Financial architecture includes funding, reporting processes.. 4. Strategic architecture: The linkage between the company's vision and its current position which takes the form of managers with strategic mindsets rather than the existence of strategic plans.. Hamel and Prahalad take a 'radical' view of the future and make two propositions:. 162. . The future is not just something that 'happens' to organisations.. . Organisations can 'create' the future.. © The Institute of Chartered Accountants in England and Wales, March 2009.

(13) STRATEGIC CAPABILITY. 5. 2.3Management competences Hamel and Prahalad claim that the management of some companies is more 'prepared' (i.e. willing and able) to shape the future than others, and that this future-orientated stance is somehow embodied in the corporate culture, (or strategic architecture). They offer a 'diagnostic' to indicate how future-orientated a company is. Diagnostic statement. Protect the past. Create the future. Senior management's viewpoint about the future is …. Conventional, reactive. Distinctive, far-sighted. Senior management spend most of their time on …. Re-engineering current processes. Regenerating core strategies. Within the industry, the company .... Follows the rules. Makes the rules. The company is better at …. Operational efficiency. Building new businesses. To what extent does the company pursue competitive advantage by …. Catching up with competitors?. Creating new sources of competitive advantage?. How is the company's agenda for change actually set?. By competitors. By a vision of the future. Are managers ..... Engineers of the present?. Architects of the future?. Are employees ..... Anxious?. Hopeful?. This is embedded in the management competence of the firm. 'Some management teams were simply more foresightful than others. Some were capable of imagining products, services and entire industries that did not exist and then giving them birth. These managers seemed to spend less time worrying about how to position the firm in existing competitive space and more time creating fundamentally new competitive space.' They identify challenges to be overcome in the development of foresightful management teams: . An inconstant environment: Experience is devalued and familiar landmarks no longer serve as guide. Environmental turbulence erodes knowledge.. . Institutional entropy: The organisation's decay undermines organisational effectiveness.. . Individual estrangement: Managers lose touch with the 'people' aspect of their role.. They say that the goal is 'not to predict the future but to imagine a future'. Strategy – if it is concerned with the long-term survival of the business – must therefore do more than play around with current products or markets. Hamel and Prahalad appear to be strong proponents of a resource-based view of strategy. Their key focus is a future orientation, based on competences.. © The Institute of Chartered Accountants in England and Wales, March 2009. 163.

(14) Business strategy. 3 Transforming resources: the value chain Section overview. 3.1. . The value chain is a common business term which received a specific formulation by Porter.. . Porter's value chain encourages management to perceive of the business as a sequence of activities that add value to inputs in order that the final good or service shall command a profitable price on the market.. . The linkages between the activities in the chain, for example how marketing and sales support operations or procurement practices support inbound logistics are common opportunities to reduce non-value adding costs, such as inventory, or enhance value to the customer.. . Competitive advantage can be created and sustained by linkages in the value chain. Extending the value chain to an underlying value system of suppliers, distributors and customers makes it hard for competitors to replicate.. . The crucial activities that sustain competitive advantage are called cost drivers and value drivers which forge a link to aspects of cost accounting.. The value chain The term 'value chain' was in common use before Porter's formulation here. In overview, value chain analysis sees the firm as an input/output device.. Firm Inputs from suppliers. Value – creating activities. Outputs to customers. The value chain consists of the organisation's resources, activities and processes that link the business together, and the profit margin. Together these create the total value of output produced by the business, quantified by the price paid by the customer. Porter groups the various activities of an organisation under generic headings that he claims can be observed in all organisations. The groupings do not correspond to the functional divisions of the organisation structure but rather are deliberately formulated to help identify the activities carried out by the firm in the generation of value to a customer.. HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT. MA IN RG. SUPPORT ACTIVITIES. FIRM INFRASTRUCTURE. PROCUREMENT. M A RG I. MARKETING OPERATIONS OUTBOUND LOGISTICS AND SALES. PRIMARY ACTIVITIES. 164. © The Institute of Chartered Accountants in England and Wales, March 2009. SERVICE. N. INBOUND LOGISTICS.

(15) STRATEGIC CAPABILITY. 5. The margin is the excess the customer is prepared to pay over the cost to the firm of obtaining the necessary resource inputs and of performing value-creating activities upon them before selling them to the customer.. Worked example: Discount food stores Kwik Save's ability to compete with the major grocery multiples depended on a cost based competitive strategy which was sustained throughout the value chain. Linkages throughout the value chain – Kwik Save Discount stores Minimum corporate HQ Computerised warehouse. M A. Checkouts simple. R G. De-skilled store-ops P. Branded only purchases Big discounts Bulk warehouseing. I. Dismissal for checkout error. N. Low cost. Use of concessions. sites 1,000 lines only. Low price promotion. Price points. I G R. Local focus. A. Basic store M. design IL. OPS. N. Nil. OL. M/S. SER. Kwik Save's strategy was based on ability to provide low-priced goods supported by a low-cost operation. The whole of the operation was designed for this purpose. The corporate headquarters was simple with few staff; bulk, computerised central warehousing fed stores with a limited number of branded-only lines. Because the policy was branded goods only, Kwik Save was able to obtain maximum discounts from manufacturers. Stores themselves were basic in design and the approach to merchandising simple; time and costs were saved by not price-marking goods, but keeping the number of price points to a minimum and requiring checkout staff to recall prices accurately. Store managers were required to keep to a simple and relatively deskilled operation with branded goods only; more complete areas of greengrocery and butchery were dealt with on the basis of concessions. Overall, the marketing approach of the store group was to promote a discount image to the local community. Source: 'Kwik Save Discount', case study by Derek Channon, Manchester Business School.. © The Institute of Chartered Accountants in England and Wales, March 2009. 165.

(16) Business strategy. 3.2. Value activities Primary activities relate to production, sales, marketing, delivery and service, in other words anything directly relating to the process of converting resource inputs into outputs. Activity. Comment. Inbound logistics. Receiving, handling and storing inputs to the production system (i.e. warehousing, transport, stock control etc).. Operations. Convert resource inputs into a final product or service. Resource inputs are not only materials. 'People' are a 'resource', especially in service industries.. Outbound logistics. Storing the product and its distribution to customers: packaging, warehousing etc.. Marketing and sales. Informing customers about the product, persuading them to buy it, and enabling them to do so: advertising, promotion etc.. After sales service. Installing products, repairing them, upgrading them, providing spare parts, advice (e.g. helplines for software support).. Support activities provide purchased inputs, human resources, technology and infrastructural functions to support the primary activities. Each provides support to all stages in the primary activities. For instance procurement where at each stage items are acquired to aid the primary functions. At the inbound logistics stage it may well be raw materials, but at the production stage capital equipment will be acquired, and so on.. 3.3. Activity. Comment. Procurement. Acquire the resource inputs to the primary activities (e.g. purchase of materials, subcomponents, equipment).. Technology development. Product design, improving processes and/or resource utilisation.. Human resource management. Recruiting, training, developing and rewarding people.. Management planning and firm infrastructure. Planning, finance, and quality control: these are crucially important to an organisation's strategic capability in all primary activities.. Linkages Activities in the value chain affect one another. Linkages connect the activities in the value chain. They have two roles. . They optimise activities by enabling trade offs. For example, more costly product design or better quality production might reduce the need for after sales service.. . Linkages reflect the need to co-ordinate activities. For example, Just In Time (JIT) requires smooth functioning of operations, outbound logistics and service activities such as installation.. These linkages are often unrecognised, especially if there is a rigid functional structure. A value chain analysis can help draw them to management's attention and so improve business performance.. 166. © The Institute of Chartered Accountants in England and Wales, March 2009.

(17) STRATEGIC CAPABILITY. 5. Worked example: Linkage examples . Common source material or components (e.g. many different marques of car share similar components, as is shown by VW and Audi).. . Common services (e.g. HRM).. . The cost/performance of direct activities can be improved by indirect activities. Take the links between technology development and production. It is possible to speed a new product to market if the manufacturing technology is considered at the same time as when the product is being designed.. . The same function can be performed in different ways. (For example, conformance to quality specifications can be assured by high quality inputs, TQM techniques, 100% inspection and so on).. . Activities performed within one form reduce the need for service costs. (100% inspection or TQM can reduce maintenance visit.). . Inter-company linkages, in support of strategic alliances, such as airline reservation systems.. Cost drivers Using the value chain as a basic analysis tool, it is possible to look at each of the value activities and identify the major influences on the costs incurred. These structural factors which influence cost are the cost drivers, and the factors which influence the cost of a given activity may vary, even between competitors in the same industry. An understanding of cost behaviour will allow a firm to assess the possibilities of adopting a least cost competitive stance. Internet technologies can reduce production times and costs by improving information flows as a way of integrating value activities, e.g. by making procurement more efficient or sharing demand information with suppliers. Value drivers Unlike cost drivers, the potential sources of value are likely to be many and varied. An understanding of the value drivers for a particular key value activity is essential for a firm trying to differentiate itself from its competitors. For example, if competitive advantage centres on the durability of a product, then this can be supported by the sourcing of components, product design and maintenance services offered (the key value activities). In turn the value drivers for these support activities might be supplier vetting and approval procedures, the use of freelance designers and in-house after-sales service teams.. 3.4. The 'value system' A firm's value chain is connected to what Porter calls a value system, i.e. activities that add value that extend beyond the organisation's boundaries. For example, when a restaurant serves a meal, the quality of the ingredients – although the cook chooses them – is partly determined by the grower. The grower has added value, and the grower's success in growing produce of good quality is as important to the customer's ultimate satisfaction as the skills of the chef.. © The Institute of Chartered Accountants in England and Wales, March 2009. 167.

(18) Business strategy. Distributor/retailer value chains Organisation's value chain. Customer value chains. Supplier value chains. 3.5. The value chain and competitive advantage Competitive advantage can be sustained by linkages in the value chain and also in the wider value system of suppliers, distributors and customers. The planning of these linkages can provide the basis for cost advantages or become the basis on which the firm's products are differentiated from those of competitors. Competitors can often replicate parts of a value chain but it is more difficult to copy linkages. As businesses outsource more and more activities, the links in the value system become more important. Electronic communications enhance the ability of businesses to outsource. The factors that sustain the competitive position through these key activities are cost drivers and value drivers, and are outlined below. Here are some examples of how companies – in practice – aim to differentiate themselves. They may not have consciously used the value chain but you can see how thinking about various activities of a business can help solve a strategic problem: in this case, commoditisation.. Worked example: Escaping commoditisation Commoditisation is what many manufacturers seek to avoid: history is full of examples of one-time world-beating products – such as rolling bearings, chemicals and memory chips – that have been copied and have lost their distinctiveness and price advantages. Commoditisation basically results in price competition as products and companies are identical. Not every firm can pursue 'cost leadership' and many firms seek to add value by escaping from the commodity trap and pursuing differentiation. Here are some examples.. 168. . Choose the value system: 'Focus on a niche' is the strategy employed by many of Germany's engineering companies. By selling their products into a small market across the world, they gain the economies of scale and expertise to deter new entrants. They are part of a value system, but have chosen their customers very carefully.. . Set the standards which others must adhere to, such as Intel for PC chips. It does, however, suggest the need for overwhelming competence in the technology and marketing areas of the value chain.. . Differentiate commodity products by branding; again this is partly a matter of customer perception (an aspect of sales and marketing).. . Control the process: Some manufacturers dominate not a product but an operations process that creates a 'cluster' of product opportunities. 'Vacuumschmelze', a German company, makes products for industries including electronics, cars, electricity distribution and retailing. The German company's expertise starts with the techniques it uses to melt and form tiny components made from exotic metals including nickel, cobalt, neodymium and samarium, as well as non-metals such as silicon and boron. A division of Morgan Crucible, the UK engineering company, it owns about 1,000 patents in these disciplines.. © The Institute of Chartered Accountants in England and Wales, March 2009.

(19) STRATEGIC CAPABILITY. . 3.6. 5. Add services: 'Heidelberger Druckmaschinen', the world's leading maker of printing presses, has set up 'print academies' in nine cities around the world to organise courses on printing techniques for customers and potential customers. This is clearly an example of after-sales service being used to build customer relationships.. The value chain: cost drivers and value drivers The value chain models the process by which organisations convert inputs into outputs, thereby adding value. Most products are a collection of benefits, which is why customers buy them. Ultimately, the provision of customer benefits is the real cost driver of a business, and it should be possible to work backwards, as it were, from customer 'value' to the underlying costs. The costs of the value chain are influenced by the following factors. Cost drivers Using the value chain as a basic analysis tool, it is possible to look at each of the value activities and identify the major influences on the costs incurred. For example supermarkets regard the diversity of products (food, clothes, spirits, audio, etc) stocked as cost drivers because for each additional product line stocked the supermarket incurs the costs of logistics, stocking, stacking, programming electronic point of sale systems (EPOS), product training and promotion costs. An understanding of cost behaviour will allow a firm to assess the possibilities of adopting a least cost competitive stance. Value drivers Unlike cost drivers, the potential sources of value are likely to be many and varied. An understanding of the value drivers for a particular key value activity is essential for a firm trying to differentiate itself from its competitors. For example, if competitive advantage centres on the durability of a product, then this can be supported by the sourcing of components, product design and maintenance services offered (the key value activities). In turn, the value drivers for these support activities might be supplier vetting and approval procedures, the use of freelance designers and in-house after-sales service teams.. 3.7. Use in strategic planning The principal use of the value chain is to assist in an understanding of the business and its strengths and weaknesses, as a form of position analysis. However, the value chain can be used specifically to: . Identify strategically significant activities (the value activities) as an aid to targeting capital investment. . Compare with the value chains of competitors, to identify sources of differentiation. . Identify opportunities for synergy between the firm and a potential acquisition, for example opportunities to transfer skills or share activities. These will be examined in more detail in the mergers and acquisitions section of Chapter 10.. The value system highlights the relationship between a firm and its customers and suppliers. . This will assist managers in identifying competitive forces in the system, and targeting potential vertical integration prospects.. . Management of these wider linkages can make it more difficult for competitors to replicate the organisation's value chain and hence contributes to sustainable competitive advantage.. © The Institute of Chartered Accountants in England and Wales, March 2009. 169.

(20) Business strategy. Interactive question 2: Hairdressers. [Difficulty level: Exam standard]. X Ltd is a chain of hairdressers with fourteen sites operating in the business districts of the capital and three other major cities. It has a very simple philosophy – quality haircuts for women who are short of time. It operates a no appointment, drop-in system. Customers take a ticket on arrival and wait in a large comfortable seating area until their numbers are called. All staff are multi-skilled and there are no specialists. The company aims to keep waiting times below fifteen minutes. The salons offer a wide range of services from very simple cuts to more complex styles and treatments. In 50% of their stores X Ltd also offers beauty treatments, such as facials, in a separate salon on site. The company's main publicity comes from personal recommendation by satisfied customers, but they also occasionally advertise in high quality women's magazines. After a recent period of expansion, the management team of X Ltd feel that their business model is not being applied consistently throughout the organisation and they have decided improvements and adjustments need to be made. However, none of the management team knows how to relate their philosophy to their operations to the best effect. Requirements (a). Using the concept of the value chain, explain how X Ltd can adopt the quality and speed approach throughout its activities.. (b) What are the benefits and problems of value chain analysis for a company such as X Ltd? See Answer at the end of this chapter.. 4 Networks, relationships and architecture Section overview. 4.1. . The sections above have focused on assets and operations within the boundary of the corporation and so under management control.. . Network analysis recognises that businesses are frequently webs of networks between departments and also with outside contractors, customers, and suppliers.. . This gives rise to the importance of understanding the relationships between the partners and the value of relational contracts based on trust and commitment to replace transactional contracts in which each side tries to get the greatest gain for itself.. . The practice of outsourcing is one step in creating these networks.. . Supply chain management (SCM) is the management process, often assisted at the operational level by high power IT applications, of synchronising the networks in the service of the final customer.. . The virtual firm is introduced and a modern organisational structure which replaces vertically integrated businesses with a high reliance on networks.. What do we mean by architecture? The concept of the value system suggests a variety of interrelationships between different businesses. We shall now explore the nature of some of these relationships.. Definition Architecture: the network of relational contracts, within or around, the firm.. 170. © The Institute of Chartered Accountants in England and Wales, March 2009.

(21) STRATEGIC CAPABILITY. 5. A relational contract contains parties doing business with each other in a long term relationship. Its provisions are only partly specified but it is enforced not by legal process but by the needs the parties have to go on doing business with each other (as opposed to a spot contract which is a one-off transaction). These relational contracts may have a legal basis, but also include a pattern of expectations that the parties have of each other. Firms may establish these relationships in two ways, internally and externally. Internal networks. Organisation structure and culture; job descriptions and work patterns to encourage development; employment contracts (e.g. employer commitment vs 'short term hire'); remuneration structure to encourage 'loyalty', 'creativity' and a willingness to satisfy individual preferences for the collective's benefit.. …with and among their employees (internal architecture) External networks …with their suppliers or customers (external architecture) among firms engaged in related activities (Kay, 1993). Relationships with suppliers – e.g. long-term supply contracts, detailed design specifications – firms share knowledge and establish fast response times on the basis of relational contracts. Networks are groups of firms making relational contracts with each other, who need to do business together in the long term, and who arguably depend on a common skills base.. It is clear that the idea of networks of relational contracts is very wide in scope. Note the phrase 'relational contract'. We are not simply discussing 'communication pathways'; these related contracts are activities embedded in business relationships built up over time. Some writers distinguish between contracts under which both sides still retain selfish behaviour (termed a transactional relationship or dyadic contracts) and contracts that are founded on commitment and trust (a collaborative relationship).. 4.2. Networks and organisational co-operation In many industries, collaborative ventures and strategic alliances are becoming increasingly common. They can be very complex. Alliance Manufacturer A. Manufacturer B. Manufacturer C. Supply agreements Manufacturer D. Joint venture. Wholesaler Distributor. Customer. © The Institute of Chartered Accountants in England and Wales, March 2009. 171.

(22) Business strategy. Worked example: Rail networks In 1994 the UK government broke up and sold the national railways provider, British Rail, to private investors. To avoid the possibility of private monopolies exploiting the customer it was sold off in pieces as different companies. On the day following privatisation a typical passenger's journey would have involved the following networks: . The car park they parked in was operated by a private firm under a license agreement from the firm owning the railway station.. . The station was operated either by Railtrack, the company set up to run infrastructure, or by the rail operator with the greatest use of the station. In the latter case the other rail operators would lease 'slots' at the station for their trains to stop there.. . The platform information on train arrivals was provided by Railtrack because it is based on the signalling systems they provide.. . The timetables of the rail operators were co-ordinated by Railtrack who also operated a telephone National Rail Enquiries service.. . The ticket purchased was sold by the station operator but if there was 'through-ticketing' across rail operators there would be recharges on to another.. . The train was operated by the rail operator.. . The rolling stock was owned by a separate leasing company.. . Cleaning, catering, track maintenance etc were largely contracted out by the rail operators and by Railtrack to private firms.. The success of this network approach has been questioned in the years since it was created. In 2007 elections for the Scottish Assembly featured the major nationalist party pledging to return the railways of Scotland back to nationalised status under a Scottish National Railways Authority.. As can be seen from the rail example above there are many types of organisational forms that can be developed. Networks display, horizontal (e.g. joint ventures) and vertical (supply chain) linkages. Drivers of collaboration strategies that result in network arrangements can be characterised as follows.. 4.3. . Blurring of market boundaries: E.g. convergence of telecommunications and computing. This increases the complexity of technologies.. . Escalating customer diversity: Customers are becoming more demanding. In global markets, customers are more diverse almost by definition.. . Skills and resource gaps: Firms need to collaborate in technologically demanding markets.. Types of external network It is possible to model types of network on the axes of environmental volatility or turbulence and the type of network relationship, as in the figure below.. 172. . For the sake of this discussion, we can take volatility to be analogous with environmental turbulence.. . The type of network relationship can range from the collaborative to mainly transactional (just a buy-sell relationship). A collaborative network involves a great deal of co-operation, which may be enshrined in joint venture agreements. In a transactional relationship, there is no commitment to the long term.. © The Institute of Chartered Accountants in England and Wales, March 2009.

(23) STRATEGIC CAPABILITY. 5. Environmental turbulence Low. High. Collaborative. Virtual network. Flexible. Transactional. Value-added. Hollow. 1. A hollow network combines high environmental volatility with a transactional-based approach. The organisation draws heavily on other organisations to satisfy customer needs. Such organisations can be quite small, but have a large number of contacts. For example, in the publishing industry, there are print brokers who will deal with a variety of printing needs by accessing a network of subcontractors.. 2. Flexible network: This is a collaborative network existing in conditions of high environmental turbulence. The links between organisations are of a long-term nature, but are on specific projects. For example, pharmaceuticals companies aim to build up alliances with biotechnology firms (as their competence bases are different).. 3. Value-added network: Environmental turbulence is low and the organisation adopts transactional relations. This is typical of many Japanese firms. Publishers have subcontracted printing to specialist printing firms for many years. The outsourcer is performing a standard service.. 4. Virtual network: Environmental volatility is low but the organisation wants to build collaborative relationships with other organisations. A firm wishes to use the network to achieve adaptability to meet the needs of segmented markets through long-term partnerships rather than internal investment.. Definition Asset specificity: Where investments are made to support the relationship which have the effect of locking parties into a relationship to some degree.. Relationship-specific assets An example is the investment by the Anglo-French company Eurotunnel in an undersea rail link that locks Eurotunnel into partnerships with the rail operators using it from either end, (i.e. Eurostar and SNCF). Both sides required long-term contracts before they would make the commitments necessary. Asset specificity can take four forms. . Site specificity: Assets are located side by side to economise on transport or processing efficiencies.. . Physical assets specificity: Asset properties are tailored to a specific transaction.. . Dedicated assets: Investment is made in plant and equipment in order to serve a particular customer.. . Human assets specificity: Workers acquire skills, know-how and information specific to the relationship, but of less value outside it.. If a firm makes a relationship-specific investment, this implies that it would not make sense to make the investment outside the business relationship (e.g. if the component was so specialised no-one else would buy it).. © The Institute of Chartered Accountants in England and Wales, March 2009. 173.

(24) Business strategy The relationship between firms in a network can be close or distant, and we can model them as follows. Distant. Outsourcing – purchase of goods/services Partnership – co-ordinated/integrated activities Alliance – joint ventures: shared ownership. Close. Ownership – for example, vertical integration. Definition Alliance: An agreement between firms to share a commercial opportunity characterised by each member of the alliance retaining autonomy and pursuing its commercial interests (i.e. a dyadic relationship). Partnership: Joint participation in the serving of a market or project characterised by the close interrelationship of operations, exchange of staff and mutual trust and commitment to working with the other (i.e. a non-dyadic relationship).. Worked example: Microsoft According to The Economist (January 2007) the launch at that time of Microsoft Windows Vista may mark the pinnacle of the software giant's power. If true it provides an example of a business that grew rich on its pivotal position at the hub of one type of network, the need for PC users to be able to transfer documents to each other by using common software packages, now being superseded by an new kind of virtual network of PC users, open-source programmers and hackers. 'Microsoft's dominance is slowly being eroded. Who produces the plumbing for a personal computer matters a lot less than it did in 1995. More PCs talk to each other using open standards rather than proprietary ones. Many services and some programmes are accessed on-line. Much software is based on the Internet. These changes are bad for Microsoft. Windows and Office are the backbone of the company. They represent nearly 60% of sales and 80-90% of its profits. Computing has changed radically since Microsoft rose to prominence 25 years ago with its operating systems for IBM's personal computer. Three trends are changing this:. 174. 1.. The rise of open-source software: The code for this is written largely by volunteers rather than a single company. The programmes are free to use and open to continual enhancements. As a collaborative venture open source can speed up development and make it easier to add features.. 2.. The rise of software as an online service: Programmes are held on the internet rather than on the hard drive of the computers. Google and others offer free on-line word-processing and spreadsheet applications.. 3.. Problems with the security of Microsoft products: Microsoft products remain based on programming that has been around long enough for its flaws to be well known to hackers. And because it is so widely used it pays hackers to learn ways around any new security features Microsoft brings out.'. © The Institute of Chartered Accountants in England and Wales, March 2009.

(25) STRATEGIC CAPABILITY. 4.4. 5. Outsourcing value activities Definition Outsourcing: The use of external suppliers as a source of finished products, components or services previously provided in-house.. Research by PricewaterhouseCoopers (a major provider of outsourced services) has found that when most business processes are stripped down to their basics, about 70% of business processes are common to all firms. This suggests that they could be outsourced without loss of competitive advantage. With the help of technology and telecommunications it is now possible for one service provider to devise a common process to deal with many different local processes in a single location. In addition to cost considerations management may take the view that a chain is only as strong as its weakest link and therefore supply chains can be strengthened by outsourcing weak links to more competent providers. The issues to be considered in deciding whether to outsource include: . The firm's competence in carrying out the activity itself. Low competence implies high cost and risk of poor performance.. . Whether risk can be managed better by outsourcing, e.g. shift legal liability to the provider and possibly also levy charges for breakdowns in performance that will mitigate losses.. . Whether the activity can be assured and controlled by the framework of a contract and performance measures, e.g. outsourcing payroll can normally be done relatively easily but systems development is more open-ended.. . Whether organisational learning and intellectual property is being transferred. The in-house operation may be a source of significant learning leading to product and process improvement. This is one reason that in the early stages of the international production life cycle (Chapter 3) firms keep manufacturing in-house rather than outsource to cheaper contract manufacturers.. The issues to consider in deciding whom to outsource to include: . The track record of the provider and its experience of similar partnerships.. . The quality of relationship on offer, e.g. will they place staff at your premises, hold regular meetings, provide open-book accounts?. . The strategic goals of the provider, e.g. is this their core business, will they operate globally alongside the firm?. . The economic cost of using them (including whether they will take staff over and pay for transferred assets).. . Their financial stability.. Interactive question 3: Outsourcing R&D. [Difficulty level: Easy]. Give two advantages and two disadvantages of a computer software company outsourcing its research and development. See Answer at the end of this chapter.. © The Institute of Chartered Accountants in England and Wales, March 2009. 175.

(26) Business strategy. 4.5. Supply chain management Definition Supply chain management (SCM): The management of all supply activities from the suppliers to a business through to delivery to customers.. This may also be called demand chain management (reflecting the idea that the customers' requirements and downstream orders should drive activity) or end-to-end business (e2e). In essence it refers to managing the value system. Technology is vital to SCM, given the vast flow of information between suppliers, customer and intermediaries. The main themes in SCM are: . Responsiveness – the ability to supply customers quickly. This has led to the development of Just in Time (JIT) systems to keep raw materials acquisition, production and distribution as flexible as possible.. . Reliability – the ability to supply customers reliably.. . Relationships – the use of single sourcing and long-term contracts better to integrate the buyer and supplier.. Example: Tesco information exchange Tesco Information Exchange (TIE) uses information technology to improve the reliability of its supply chain. Suppliers receive information on actual store demand, depot inventories, weekly sales forecasts, as well as daily point of sale information, to help forecast demand.. Technology Technology applications which have facilitated SCM include: . E-mail. . Web-based ordering and tracking. This involves outsiders seeing some management information on an extranet. . Electronic data interchange (EDI) of invoices and payments, ordering and sharing of inventory information. . Satellite systems able to track positions of trucks. . Radio data tags fixed to pallets or boxes of valuable items to enable them to be located in the supply chain (including within a warehouse). This has led to:. 176. . Reductions in costs. . Better outsourcing opportunities. . Increased product and service innovation. . Mass-customisation of products: i.e. customised products made by mass production methods, e.g. Dell computers, superior car marques.. © The Institute of Chartered Accountants in England and Wales, March 2009.

(27) STRATEGIC CAPABILITY. 4.6. 5. Supply chain networks Supply chain management involves optimising the activities of companies working together to produce goods and services. . Reduction in customers served: For the sake of focus, companies might concentrate resources on customers of high potential value.. . Price and stock co-ordination: Firms co-ordinate their price and stock policies to avoid problems and bottlenecks caused by short-term surges in demand, such as promotions.. . Linked computer systems: Electronic data interchange and use of intranets saves on paperwork and warehousing expense.. . Early supplier involvement in product development and component design.. . Logistics design: Hewlett-Packard restructured its distribution system by enabling certain product components to be added at the distribution warehouse rather than at the central factory, for example user-manuals which are specific to the market (i.e. user manuals in French would be added at the French distribution centre).. . Joint problem solving.. . Supplier representative on site.. The aim is to co-ordinate the whole chain, from raw material suppliers to end customers. The chain should be considered as a network rather than a pipeline – a network of vendors support a network of customers, with third parties such as transport firms helping to link the companies.. 4.7. Networks in action: alliances and the virtual firm Some firms enter long-term strategic alliances with others for a variety of reasons. . They share development costs of a particular technology.. . The regulatory environment prohibits take-overs e.g. most major airlines are in strategic alliances because in most countries there are limits to the level of control an 'outsider' can have over an airline.. . Complementary markets or technology.. Strategic alliances only go so far, as there may be disputes over control of strategic assets. Choosing alliance partners The following factors should be considered in choosing alliance partners. Drivers. What benefits are offered by collaboration?. Partners. Which partners should be chosen?. Facilitators. Does the external environment favour a partnership? Relevant factors here would include the availability of suitable providers, legal environment that does not outlaw collaboration as anti-competitive, and high investment costs involved in establishing provision that could not be borne by a single user of the service.. Components. Activities and processes required by the network. What will the alliance partner contribute?. Effectiveness. Does the previous history of alliances generate good results? Is the alliance just a temporary blip? For example, in the airline industry, there are many strategic alliances, but these arise, in part, because there are legal barriers to crossborder ownership.. Market-orientation. Alliance partners are harder to control and may not have the same commitment to the end-user.. © The Institute of Chartered Accountants in England and Wales, March 2009. 177.

(28) Business strategy Alliances have limitations. 4.8. 1. Core competence: Each organisation should be able to focus on its core competence. Alliances do not enable it to create new competences.. 2. Strategic priorities: If a key aspect of strategic delivery is handed over to a partner, the firm loses flexibility. A core competence may not be enough to provide a comprehensive customer benefit.. Networks and global business There are some distinct forms of global business network. Keiretsu and chaebol These are business networks common in Japan and Korea, whereby groups of firms are linked in a number of different ways.     . A general trading company exists at the centre. A central bank circulates finance from one activity of the network to another. Many of them have received favourable treatment from the state. There are cross shareholdings between companies. They depend on personal relationships and agreements: high trust.. In both countries, such firms have made high investments and typically result in conglomerate diversification. This business model has come under attack, as a number of chaebol have collapsed recently. Family networks Networks based on family structures are common in businesses run by overseas Chinese according to Dicken (Global Shift). The family – a relatively small group of insiders – is key to decision making, and operates on the following principles. . The purposes of the firm is 'the long-term interest on family prosperity'.. . Risks must be hedged to protect family assets.. . Key decision makers exist in an inner circle.. . Such firms do not trust non-family members.. . Personal obligations cement and reinforce non-contractual business relationships.. The network is exclusive, but family loyalties mean effective business co-ordination in many countries. Networks and globalisation Networks and relationships on any number of levels may be suitable for global businesses. When these are linked to the type of geographic cluster identified in Chapter 3 there is the potential for considerable complexity.. 4.9. The virtual firm An extreme example of networking is the so-called virtual firm. It is created out of a network of alliances and subcontracting arrangements. It is as if most of the activities in a particular value chain are conducted by different firms, even though the process is loosely co-ordinated. This will be discussed in more detail in Chapter 8.. Interactive question 4: Outsourcing and core competences [Difficulty level: Easy] Should a core competence ever be outsourced? See Answer at the end of this chapter.. 178. © The Institute of Chartered Accountants in England and Wales, March 2009.

(29) STRATEGIC CAPABILITY. 5. 5 The product-service portfolio Section overview. 5.1. . Firms with multiple products (e.g. consumer goods firms like Heinz) or multiple business units (e.g. GE) are said to be managing a portfolio of businesses in the same way as a fund manager might manage a portfolio of stocks and shares.. . The Boston Consulting Group matrix (BCG matrix) is a graphical technique to assist management to visualise their portfolio and to manage it to improve the financial performance of the corporation as a whole.. . The GE Business Screen is an alternative to the BCG matrix, which takes a broader view of the factors making a business unit competitively strong and its industry financially attractive.. . Treating businesses as investment portfolios was popular in USA and Europe in the 1960s and 1970s but has declined in favour since, with the search for core competences and core businesses. This has led to a re-evaluation of the concept of portfolio analysis.. The need for a mix of products and services Many businesses sell more than one type of product or service. For example: . Accounting firms sell audit services, tax advisory services, accounting services and so on. . Consumer goods companies such as Procter and Gamble sell a mix of products such as soap powder, children's nappies, cosmetics, drinks, dental hygiene products and shaving products (amongst many others).. These are sold in different markets because of technological and social change, the influence of competition, the demands of shareholders that their investments grow and so on. Portfolio analysis is a term originating in investment markets and refers to the fact that investors typically have a mix of different securities in a portfolio. Investment portfolios seek to strike a balance between:  . Income and capital growth Risks and returns.. Product portfolio analysis invites management to think of the collection of products and business units they have assembled in the same way.. Worked example: Portfolio management in the film industry One application might be teased out from the example below, from The Economist (17 March 2007). Film-making is inherently risky – a few successes in effect have to subsidise a number of failures. A film may be launched on a number of screens simultaneously, though perhaps in different countries at different times (this was discussed as an example of the international product life cycle in Chapter 4). There may be an initial surge of audience viewing – after a while, film goers find other distractions, the film is itself released on DVD, as a sort of 'back catalogue'. The product life cycle is relatively short. As big studios typically spend US $100m per film, they are cutting back the number of movies created, making the gamble on the few made even more risky. However, they still rely on private investors. (a). Studios encourage investors such as hedge funds to back 'slates' of several dozen films over more than a year.. (b) Investment firms might back producers with good records (rather like choosing a particularly astute fund manager). (c). Investors can choose to invest in smaller 'independent' firms – some low budget productions can be very profitable, as can films targeted at particular audiences.. © The Institute of Chartered Accountants in England and Wales, March 2009. 179.

(30) Business strategy The lessons are: . A film has a life cycle. For a studio to remain in business, it needs to have films in production to launch in future seasons.. . Film making is risky, and a portfolio of products helps spread the risk.. Similar considerations apply in other industries.. 5.2. Product life cycle (PLC) revisited Many businesses will not wish to risk having only a single product (or group of closely related products) or all their products at the same stage of development. Many will seek to maintain a balanced portfolio of products with variety to protect against downturns in the fortunes of individual products and to have products at different stages of development. The product life cycle and BCG models (to be discussed shortly) can help assess the balance of a product portfolio. Strategies for each stage can be summarised as: 1.. 2.. Introductory stage . Attract trend-setting buyer groups by promotion of technical novelty or fashion. . Price high (skim) to cash in on novelty or price low (penetration) to gain adoption and high initial share. . Build channels of distribution. Growth stage    . 3.. 4. Build brand awareness to resist impact from new entrants Improve and refine product features High promotion of benefits to attract early majority of potential buyers Penetrate market, possibly by reducing price. Maturity stage . Defend market position by matching pricing and promotion of rivals. . Modify markets by positioning product to gain acceptance from non-buyers (e.g. new outlets or suggested new uses). . Modify the product to make it cheaper or of greater benefit. . Intensify distribution. Decline stage   . Harvest cash flows by minimising spending on promotion or product refinement Simplify range by weeding out variations Narrow distribution to target loyal customers to reduce stocking costs. The response of competitors is particularly important – there may be threats as they attempt to defend their position, or opportunities, e.g. when a competitor leaves the market. . A company will not wish to have all products at the same stage as they may all decline together.. . Solutions: – – –. 180. Products with different length cycles. Lots of products in development/introductory stage. Lots of products in maturity to support others.. © The Institute of Chartered Accountants in England and Wales, March 2009.

(31) STRATEGIC CAPABILITY. 5. Sales of video tapes and DVDs over the last three years have followed the pattern below.. Sales CU Video tapes. DVDs. 2007. 5.3 5.3.1. Time. Boston Consulting Group matrix The basics This matrix was developed by the Boston Consulting Group (BCG) in 1968 and was based on extensive work into the presence of experience effects in industry.. Definition Experience effects: An explanation of the observed trend for unit cost to decline as cumulative output increases which attributes the decline to organisational learning.. BCG estimated that unit costs typically declined by 15% for every doubling of cumulative output. A company analyses its own position along two dimensions:. Market attractiveness –% rate of market growth. Market strength – relative market share. © The Institute of Chartered Accountants in England and Wales, March 2009. 181.

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