8.15 Strategy

Strategy is the practical application of a business model to a company's particular situation and plans. Among other aims, it should:

1. Define the key operating parts of the business, where the company needs to act differently to be successful.
2. Assess the overall improvements to be had by changes in the key parts.
3. Show where most earnings and profits lie, and why this is.
4. Point to skills the company needs to acquire or develop.
5. Identify business segments or product lines that should be phased out or sold.

First Steps

The first requirement is an analysis of the company or proposed company along the lines of the business model, i.e. break the company's operation into its component building blocks or elements and understand and quantify these as much as possible.

1. Customer Segments
2. Value Propositions
3. Customer Channels
4. Customer Relationships
5. Revenue Streams
6. Key Resources
7. Key Activities
8. Key Partnerships
9. Cost Structure

The following, when quantified, will assess the company's competitiveness in the market sector or sectors in which it does business:

1. Company's relative market share (RMS) in the relevant market sector.
2. Current trend of the RMS.
3. Expected or predicted annual future growth in the relevant market sector.
4. Return on capital employed (ROC or ROCE), both of the company and the average applying to their market sector.

Relative market share is the market share a company enjoys in some market sector divided by the market share of the largest competitor in the segment. If the company has the number one position in the sector, then its RMS will be a figure exceeding one.

Results are often presented as simple graphs.

1. Product growth versus market growth for products where size of circles is proportional to sales revenues:

Products B and C are clearly losing out to the competition.

2. Expected growth versus market share, where growth is in units sold rather than dollars. The comparison yields the famous BCG (Boston Consulting Group) matrix of:

Cash cows that provide the bulk of a company's sales and profits.
Stars that need to be developed quickly.
Dogs, that are a mixed group, those on the right being poised for market leadership and those on the left requiring to be dropped or sold.
Question marks containing some future stars but costly to develop: select the best and sell the others.

3. Relative market share versus return on sales.

Products F and G are generating a negative figure for return on sales, i.e. losing money.

4. Return on capital versus relative market share:

Three quarters of businesses tend to fall in the normal zone because RMS share does generally correlate with profitability (here return on capital) . Those above and to the right of this 'banana' zone are termed vulnerable because experience has shown that such segments with high returns on capital but small market share are not sustainable in the long term: market share must increase or profits fall. Product F represents an opportunity if the associated competencies can be improved.

Industry Attractiveness

Competitiveness or winning the race is of first importance. Second comes the attractiveness of an industry or market sector, i.e. how much the race is worth winning. Experience suggests that the first accounts for some 70% of a company's profitability, and the second for some 30%. A good industry or market to be in will have these characteristics:

1. High returns on capital for the players accounting for most of the market.
2. Stable or rising average industry return on capital.
3. Clear and high barriers to entry, keeping out new entrants.
4. Low exit barriers.
5. Capacity at or below the level of demand.
6. Reasonable to high market growth.
7. Few threats from substitute products or services.
8. Low bargaining power of suppliers.
9. Low bargaining power of customers.

Some general points. These exercise are most difficult for newcomers. Well-established companies will have their quantified business models, though it never hurts to redefine or reexamine the model. Return on capital employed is crucial, and poor averages for market sectors are often not apparent to outsiders. A falling ROC is a warning, though many large companies (e.g. oil and mining companies) invest heavily at the outset but gradually show better figures as production builds. Barriers to entry include high costs to build, brand or switch production, access difficulties with supplies, property, expertise, patents, and aggressive attitudes of large competitors. Barriers to exit include costs of firing employees, investment write-offs, sale of property, equipment, intellectual property, etc. and non-economic factors such as pride or desire to keep a business empire. Threat from substitutes can arise from competing technologies (gas, electricity and nuclear power versus coal, or airlines versus railways), or simply from changing lifestyles (healthier versus less healthy foods, etc.). The relative bargaining power of the industry over its suppliers and customers is generally increased if the industry is dominated by a few big companies (e.g. supermarkets in groceries).

Competencies

Companies do not have to excel in all business segments to succeed, but they do need to identify and excel at the key competencies. On competitor research there is a range of views. One extreme holds that competitors must be understood exhaustively if they are to be beaten. The other tends not to worry overmuch about competitors but focuses instead on their own company performance, identifying and improving the important competencies. Most companies lie somewhere between the two.

Questions

1. What is meant by relevant market sector? Give some examples for Internet companies
2. You have to make a Board presentation on company strategy. What matters would you cover in your introduction?
3. What is the Boston Consulting Group matrix? Illustrate its use with two brief case studies.
4. What is relative market share commonly compared against? How can these plots be useful?
5. Explain competitiveness in and attractiveness of a market sector. What factors commonly make a market sector attractive?
6. What the two views regarding competencies? How are the market sectors likely to differ if one or the other view is more correct?

Sources and Further Reading

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