Chapter 6: Other elements of strategic choice

Chapter learning objectives

Upon completion of this chapter you will be able to:

• analyse, in a scenario, the development directions available to an organisation using Ansoff Matrix and a TOWS matrix
• use the Ansoff matrix to develop growth strategies for a business
• explain the use of the success criteria of suitability, acceptability and feasibility in appraising a chosen strategy.

1 Introduction

This chapter examines other ways in which organisations can grow.This will extend strategic choice beyond competitive strategies and willoften mean looking at new products and markets.

The chapter closes with a discussion on how strategies should be evaluated – this is a key exam area.

2 SWOT (TOWS) analysis and strategic direction

Introduction

Strategic direction should 'fit' the results of the swot analysis.Used in this way a SWOT analysis is sometimes referred to as a TOWSmatrix.

Examples of the use of the TOWS matrix

Illustration – SWOT (TOWS) analysis & strategic direction

(1)A company has a prestigious brand name and is wondering whether or not to enter a new emerging foreign market.

Suggestion: (SO) the prestigious brand name is a strength andthe emerging market is an opportunity. The company could make use of thebrand name by adopting a differentiation or focused differentiationstrategy.

(2)A company has a poor distribution network, but wants to start exporting to lucrative overseas markets.

Suggestion: (WO) Collaboration with a company that has a gooddistribution network might overcome the weakness so as to make use ofthe opportunity.

(3)A company is facing new competitionfrom cheap overseas manufacturers. The company has a long-standingreputation for good quality products.

Suggestions: (ST) The company could move towards adifferentiation strategy to try to make use of its reputation forquality to counter the competitive threat. This might not work if theimports were also of good quality and cheaper. Perhaps relocatingmanufacturing abroad would give a low cost-base but retain the strengthof the company's reputation.

(4)A company has old product lines and is facing dynamic competition from new producers.

Suggestion: (WT) The most difficult scenario to deal with asnothing is going right – weaknesses and threats combined.Repositioning itself might help so that the company was seen as a sellerof more traditional goods. Spending on new design and products wouldhelp to eradicate the weakness.

Test your understanding 1

Mobius Ltd is an engineering company and has a reputation forhigh-quality production of complex metal pieces to strict deadlines. Ithas recently been suffering falling sales because composite materials,such as carbon fibre, have been able to replace many metal components.

Required:

Using a TOWS/SWOT analysis, what are the firm's options?

3 Ansoff's matrix

Introduction

Ansoff's matrix is a very useful tool and can be used in nearly everyscenario. It neatly summarises many of the strategic options facingorganisations.­­

The matrix

Generally, risk increases from quadrant A to quadrant D (risk in quadrants B and C probably about equal).

More details on the strategies in Ansoff's matrix

Market penetration – existing markets and products

This is a strategy by which a company seeks to increase the salesof its present products in its existing markets. It is aimed atincreased usage by methods such as recipes on tins and packets,attracting customers by offers and price reductions and by attractingnew users. The advertising for Guinness has been trying to attractyounger drinkers, rather than its traditional older drinkers. Note thelink here with a problem child/star product.

Methods of growth might include the following.

• Build market share – particularly suitable if the overall market is growing. The business might use discounting, increased advertising, etc.
• Develop niches – target growth in a range of targeted niches within the industry, building up overall market share. This may be particularly suitable if the organisation is small compared to competitors.
• Hold market share – particularly if the market is reducing.
• Withdrawal – seek withdrawal of other companies, through, for example, using economies of scale to lower costs and make other firms uncompetitive.

The ease with which a business can pursue a policy of marketpenetration will depend on the nature of the market and the position ofcompetitors. When the overall market is growing it may be easier forcompanies with a small market share to improve quality or productivityand increase market activity rather than in static markets, where it canbe much more difficult to achieve. The lessons of the experience curvestress the difficulty of market penetration in mature markets where thecost structure of the market leaders should prevent the entry ofcompetitors with lower market share.

Market penetration strategy would be contemplated for the following reasons.

• When the overall market is growing, or can be induced to grow, it may be relatively easy for companies entering the market, or those wishing to gain market share, to do so relatively quickly. (Some companies established in the market may be unable or unwilling to invest resources in an attempt to grow to meet the new demand.) In contrast, market penetration in static, or declining, markets can be much more difficult to achieve.
• Market penetration strategy would be forced on a company that is determined to confine its interests to its existing product/market area but is unwilling to permit a decline in sales, even though the overall market is declining.
• If other companies are leaving the market for whatever reasons, penetration could prove easy – although the good sense of the strategy may be in doubt.
• An organisation that holds a strong market position, and is able to use its experience and competences to obtain strong distinctive competitive advantages, may find it relatively easy to penetrate the market.
• A market penetration strategy requires a relatively lower level of investment with a corresponding reduction in risk and senior management involvement.

Opportunities for improving business performance within theexisting pattern of trading will generally fall under the followingheadings.

• Advertising and promotion to increase the volume of sales into existing markets.
• Improved selling and distribution methods to improve the service offered and possibly to rationalise the market coverage.
• Modifications to products or to packaging in order to improve and broaden their appeal, and ideally to reduce costs. Some rationalisation of products may be involved.
• Improvements in productivity to make a greater volume of products available without a disproportionate increase in costs. This may involve the modification or rationalisation of production methods.
• Changes in selling price, which can be increased if the market is relatively inflexible, or reduced in order to achieve a proportionately higher volume of sales.

Even though market penetration is seen as the least risky ofAnsoff's options, it should not be assumed that risk is always low. WhenYamaha attempted to gain share over Honda, it provoked a retaliationthat left Yamaha in a worse position than before. The example shouldserve to remind us that Ansoff's strategies still require a competitiveadvantage to be effective (a point Ansoff made many times, but one thatis frequently forgotten).

Product development – existing markets and new product

This strategy has the aim of increasing sales by developingproducts for a company's existing market. For our purposes, new-productdevelopment is a generic term that encompasses the development ofinnovative new products and the modification and improvement of existingproducts. By adopting this strategy the company could:

• develop new product features through attempting to adapt, modify, magnify, substitute, rearrange, reverse or combine existing features
• create different quality versions of the product
• develop additional models and sizes.

A company might show a preference for product development strategy for the following reasons:

(a)it holds a high relative share ofthe market, has a strong brand presence and enjoys distinctivecompetitive advantages in the market

(b)there is growth potential in the market

(c)the changing needs of its customersdemand new products. Continuous product innovation is often the onlyway to prevent product obsolescence

(d)it needs to react to technological developments

(e)the company is particularly strong in R&D

(f)the company has a strong organisation structure based on product divisions

(g)for offensive or defensive motives, for example responding to competitive innovations in the market.

However, product development strategy does have its downside andthere are strong reasons why it might not be appropriate for a company.For example, the process of creating a broad product line is expensiveand potentially unprofitable, and it carries considerable investmentrisk. Empirical research reveals that companies enjoying high marketshare may benefit in profit terms from relatively high levels of R&Dexpenditure, while companies in weak market positions with high R&Dexpenditure fare badly.

There are reasons why new-product development is becoming increasingly difficult to achieve:

(a)in some industries there is a shortage of new product ideas

(b)increasing market differentiationcauses market segments to narrow with the effect that low volumes reduceprofit potential that in turn increases the risk of the investmentinvolved

(c)a company typically has to developmany product ideas in order to produce one good one. This makes newproduct development very costly

(d)even when a product is successfulit might still suffer a short life cycle with rivals quick to 'copycat'in the market but with their own innovations and improvements

(e)there is a high chance of product failure.

Success frequently depends upon stretching a brand further than the market is willing to take it.

Market development – existing products and new markets

Market development strategy has the aim of increasing sales byrepositioning present products to new markets. (Note: this strategy isalso referred to as 'market creation'.)

Kotler suggests that there are two possibilities:

(a)the company can open additional geographical markets through regional, national or international expansion

(b)the company can try to attractother market segments through developing product versions that appeal tothese segments, entering new channels of distribution, or advertisingin other media.

For example, during 1992 Kellogg undertook a major television andpromotion campaign to reposition Kellogg's Cornflakes (traditionallyregarded as a breakfast cereal) to provide afternoon and evening meals.In the same way, the malt drink Horlicks had previously repositionedfrom a once-a-day product ('a night meal') to become a through-the-day'relaxing drink' for young professionals. This was not successful. Onthe other hand, Lucozade has successfully moved its brand from a productassociated with infirmity to a sports-related product.

Market development strategy would be contemplated for the following reasons:

(a)the company identifies potentialopportunities for market development including the possibilities ofrepositioning, exploiting new uses for the product or spreading into newgeographical areas

(b)the company's resources arestructured to produce a particular product or product line and it wouldbe very costly to switch technologies

(c)the company's distinctivecompetence lies with the product and it also has strong marketingcompetence (Coca-Cola provides a good example of a company that pursuesmarket development strategies, as does the fast-food restaurant chain ofMcDonalds.)

Test your understanding 2

Describe how Porter's Generic Strategies and Ansoff's Matrix can be used when generating strategies.

Explain the limitations of the two models.

Related diversification

There are two types of related diversification:

• vertical integration
• horizontal diversification (sometimes known as concentric diversification).

Vertical integration

Taking over a supplier (backwards vertical integration) or customer (forwards vertical integration).

Horizontal diversification

Horizontal diversification refers to development into activitiesthat are competitive with, or directly complementary to, a company'spresent activities. There are three cases.

(a)Competitive products. Taking over acompetitor can have obvious benefits, leading eventually towardsachieving a monopoly. Apart from active competition, a competitor mayoffer advantages such as completing geographical coverage.

(b)Complementary products. Forexample, a manufacturer of household vacuum cleaners could makecommercial cleaners. A full product range can be presented to the marketand there may well be benefits to be reaped from having many of thecomponents common between the different ranges.

(c)By-products. For example, a buttermanufacturer discovering increased demand for skimmed milk. Generally,income from by-products is a windfall: any you get is counted, at leastinitially, as a bonus.

Illustration 1 – Horizontal diversification

Airline (SAS) owning a hotel business – horizontal diversification with obvious opportunities for cross selling

Rezidor SAS Hospitality is a wholly owned hotel group subsidiary ofthe Stockholm-based SAS Group, an airline. The hotel group currentlyoperates 248 hotels in 47 countries with nearly 50,000 rooms either inoperation or under development. It aims to have 700 hotels across itsdifferent brands by 2012. Rezidor SAS manages selected Carlson brands(such as Radisson, Park Inn, Regent and Country Inn) in Europe, theMiddle East and Africa.

Unrelated/conglomerate diversification

• Diversifying into completely unrelated businesses.
• Not clear where added value comes from – except if an ailing business is turned round.
• Often leads to loss of shareholder value.

Conglomerate diversification

Diversification

Growth by diversification – new products and new markets

Diversification is the deployment of a company's resources into newproducts and new markets. The company thus becomes involved inactivities that differ from those in which it is currently involved.Diversification strategy means the company selectively changes theproduct lines, customer targets and perhaps its manufacturing anddistribution arrangements.

The term 'diversification' actually covers a range of different techniques.

• Conglomerate diversification – a firm moves into markets that are unrelated to its existing technologies and products to build up a portfolio of businesses. Sometimes this is because the company has developed skills in turnaround or brand management, and can buy an ailing company very cheaply and quickly create value. Hanson have achieved great things in this way, based upon a nucleus of around 500 people. On other occasions, a company might use conglomerate diversification if it believes it has no real future in its existing product market domain. Finally, many entrepreneurial leaders move in and out of markets simply because of opportunities – Virgin being a good example.
• Horizontal diversification – synergy is highest in the case of horizontal diversification, especially if the technology is related, but the disadvantage is that little additional flexibility is provided. This type of strategy affects all parts of the value chain since fixed costs can be spread over an increased number of units. Most diversification strategies are of this type. The strategy is undertaken when a company extends its activities into products and markets in which it already possesses necessary expertise. For example, a manufacturer of televisions branching into the manufacture of DVD recorders, camcorders and hi-fi equipment.
• Vertical integration – a firm buys up different parts of the wider value system.

Forward integration – moving towards the consumer – control of distribution, e.g. drinks manufacturers buying public houses.

Backward integration – moving away from the consumer – control of supplier, e.g. beer brewers buying hop growers.

Many manufacturers find particular specialist component suppliersare achieving higher returns than they are, and buy into the market. Indifficult markets it might be necessary to own distributors or retailoutlets to place the product before a customer.

Suppose that a company currently manufactures cars. If the companywere to buy a chain of car dealers, this would represent forwardintegration since it is moving towards the final consumer. If thecompany were to buy a manufacturer of car components (headlights,windscreens, etc.), this would represent backward integration. A goodway to understand when a vertical integration strategy should beconsidered and how it should be evaluated is to consider its possiblebenefits and costs:

Test your understanding 3

Discuss the advantages and disadvantages for the M Company, aclothes manufacturer, in integrating forward by buying up a chain ofretail outlets and integrating backwards by buying a company thatmanufactures cloth.

4 Strategy evaluation

Introduction

Johnson, Scholes and Whittington argue that for a strategy to be successful it must satisfy three criteria:

• Suitability – whether the options are adequate responses to the firm's assessment of its strategic position.
• Acceptability – considers whether the options meet and are consistent with the firm's objectives and are acceptable to the stakeholders.
• Feasibility – assesses whether the organisation has the resources it needs to carry out the strategy.

This criteria can be applied to any strategy decision such as thecompetitive strategies assessed in the previous chapter, the growthstrategies assessed in this chapter, or even the methods of developmentconsidered in the next chapter.

Further explanation on each test

Suitability

Suitability is a useful criterion for screening strategies, asking the following questions about strategic options:

• Does the strategy exploit the company strengths, such as providing work for skilled craftsmen or environmental opportunities, e.g. helping to establish the organisation in new growth sectors of the market?
• How far does the strategy overcome the difficulties identified in the analysis? For example, is the strategy likely to improve the organisation's competitive standing, solve the company's liquidity problems or decrease dependence on a particular supplier?
• Does the option fit in with the organisation's purposes? For example, would the strategy achieve profit targets or growth expectations, or would it retain control for an owner-manager?

Acceptability

Acceptability is essentially about assessing risk and return and isstrongly related to stakeholders' expectations. The issue of'acceptable to whom?' thus requires the analysis to be thought throughcarefully. Some of the questions that will help identify the likelyconsequences of any strategy are as follows:

• How will the strategy impact shareholder wealth? Assessing this could involve calculations relating to NPV, SVA or EVA.
• How will the organisation perform in profitability terms? The parallel in the public sector would be cost/benefit assessment.
• How will the financial risk (e.g. liquidity) change?
• What effect will it have on capital structure (gearing or share ownership)?
• Will the function of any department, group or individual change significantly?
• Will the organisation's relationship with outside stakeholders, e.g. suppliers, government, unions, customers need to change?
• Will the strategy be acceptable in the organisation's environment, e.g. higher levels of noise?

Feasibility

Assesses whether the organisation has the resources it needs to carry out the strategy.

Factors that should be considered can be summarised under the M-word model.

• Machinery. What demands will the strategy make on production? Do we have sufficient spare capacity? Do we need new production systems to give lower cost/better quality/more flexibility/etc?
• Management. Is existing management sufficiently skilled to carry out the strategy.
• Money. How much finance is needed and when? Can we raise this? Is the cash flow feasible?
• Manpower. What demands will the strategy make on human resources? How many employees are needed, what skills will they need and when do we need them? Do we already have the right people or is there a gap? Can the gap be filled by recruitment, retraining, etc?
• Markets. Is our existing brand name strong enough for the strategy to work? Will new brand names have to be established? What market share is needed for success – how quickly can this be achieved?
• Materials. What demands will the strategy make on our relationships with suppliers. Are changes in quality needed?
• Make-up. Is the existing organisational structure adequate or will it need to be changed?

Test your understanding 4

Sarah Wu has set up and run her own bookstore for five years. Shefaces little local competition and has made strong financial returnsfrom the store. She now has $15,000 available for investment and plansto open up a second store in a nearby town which currently does not havea bookstore.

Her friend, Misah, has just returned from completing a universitycourse and has suggested that Sarah should instead invest in a websitefor her store. He has said that this will allow Sarah to sell her booksworldwide and make a much quicker return on her investment that the newstore opening.

Required:

Evaluate Misah's strategy.

5 Chapter summary

Test your understanding answers

Test your understanding 1

The company's strengths are:

• good quality control
• good project management (strict deadlines are met)
• competence with metalwork
• high engineering ability.

The threat arises from metal components being replaced by composite ones.

The company is in the ST segment and needs to examine strategiesthat use strengths to overcome or avoid threats. Possible strategies forMobius Ltd are:

• become even better known for metalwork. Some competitors will withdraw from the market as sales fall leaving more scope for Mobius Ltd. Presumably not all metal components will be replaced by composites
• capitalise on its engineering, quality control and project management strengths – possibly by branching into consultancy
• develop competence in manufacturing from composites – the engineering, quality control and project management abilities that Mobius Ltd has should make this easier.

Test your understanding 2

Porter was concerned with a firm's ability to generate acompetitive advantage. He classified the possible strategies for doingso into three 'generic' categories:

• cost leadership;
• differentiation;
• focus.

An organisation wishing to generate strategies could use this as a framework for producing and evaluating options:

• cost leadership can be pursued through improved efficiency, increased automation, economies of scale, etc.;
• differentiation can be pursued by real modifications to products or services, or by creating a perception of such differences by effective branding and advertising;
• focus can relate to specialisms in customer type, geographical location, product features, quality, etc.

Organisations wishing to develop strategies can use Ansoff'sMatrix, which categorises existing and new markets and products, tofocus on different combinations of products and markets:

• Staying with existing products and existing markets, but aiming to increase market penetration (as well as internal efficiency).
• Developing new products to be targeted at the existing markets.
• Opening up new markets for existing products – market development.
• Developing new products and aiming at new markets – potentially the riskiest approach.

Both of these models can be productive sources of generatingstrategies, and each provides a useful framework for evaluation ofalternatives. But each also suffers from limitations.

Porter's model implies that all the buyers in a market have perfectknowledge of all the products available to buy. If this were true, thena firm that benefits from no competitive advantage would attract nobuyers and would be doomed. In practice, the knowledge of buyers islimited and firms can prosper despite an absence of competitiveadvantage.

Ansoff's model depends upon a simplistic division of strategicfactors into product factors and market factor. Although this can helpmanagers to focus on the different aspects of a problem, the truth isthat these factors are linked.

Both models also imply that a firm will focus on one strategy tothe exclusion of others. In reality, a firm can pursue a number ofdifferent strategic objectives at the same time.

Test your understanding 3

There are several reasons why M might pursue forward integration.It will be easier for a chain of retail outlets to differentiate itsclothes from those of its competitors through branding. This gives anopportunity for higher margins to be earned. The M Company can produceclothes as the shops demand them (JIT), leading to reductions ininventory levels. They will also have a guaranteed customer for itsoutput.

There are also reasons against this course of action. The reactionof the customers that the M Company presently supplies may be hostile.If they stop stocking M Company's products, will the chain of retailoutlets be able to sell enough to cover this fall in demand? What is thelikely effect of the increased costs of distributing clothes to theshops, rather than to the depots of current customers?

A strategy of backward integration into the supply chain would givethe M Company a dedicated supplier with both guaranteed quality andprice. The material could be manufactured when required by M Company,leading to lower inventory levels.

The downside to this course of action is that, if alternativecheaper suppliers become available, the M Company will not be able touse them, since it will be committed.

There are also arguments against integration generally, whether forwards or backwards.

Being successful may require different skills from those presentlypossessed by the company. For example, M Company may know little aboutretailing or material manufacturing. To be successful, it will have tostretch its current competencies to cover these areas.

In addition, there may be a very different focus for each of thebusinesses. For example, the chain of retail outlets may well besuccessful if it can differentiate its products from those of itscompetitors using innovative colours and material, while the clothmanufacturer is likely to be successful by keeping its costs low byusing basic materials and standardised colours. It will be difficult forthe M Company to maintain both of these at the same time.

Test your understanding 4

Johnson, Scholes and Whittington's tests will be used to evaluate the strategy:

Feasibility

A website may be cheap to set up and gaining a web presence isrelatively easy. But designing the site and maintaining it will needtechnical expertise which Sarah is unlikely to possess.

Selling internationally will also require internationaldistribution networks that Sarah will not possess. She may be able tooutsource distribution, but the costs of this are likely to outweigh anybenefits.

Therefore, this strategy may not be a feasible one for Sarah.

Acceptability

As a small, owner-managed business, Sarah is likely to be riskaverse and may well want to focus on the area that she is comfortablewith. She may decide that international expansion is too risky anddifficult to control and lack the confidence necessary to run thebusiness successfully.

She is therefore unlikely to find the strategy to be acceptable.

Suitability

There are already worldwide book selling companies on the internetsuch as Amazon. They are likely to have built up a reputation and supplychain that Sarah cannot overcome. They will also have economies ofscale which enable them to sell books at a lower price than Sarah wouldfind possible and therefore Sarah's website would struggle to gain anycompetitive advantage against these rivals.

Therefore the strategy is also unsuitable.

Overall

This is not a valid strategy for Sarah to pursue and she should instead evaluate the market development opportunity further.

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