Prespective Strategy Options Evaluation- Valutrics
Strategy selection involves two aspects that should be clearly distinguished: content and process.
• Content is about what is in the plan. It means the actual strategy that is finally selected to meet the objectives of the organisation.
• Process explores such questions as who develops the plan, how they undertake the task and where they are located in the organisation.
Prescriptive strategy has taken the approach that a rational and fact-based analysis of the options will deliver the strategy that is most likely to be successful: logic and evidence are paramount in choosing between the options. The content of strategy options therefore needs to be evaluated for their contribution to the organisation. We need to be able to understand in a structured way such comments as, ‘Plausible . . . but not very likely’. We need evaluation criteria.
In practice, each organisation will have its own criteria. However, and as a starting point, we can identify six main criteria that can be used in evaluating strategy options: consistency, suitability, validity, feasibility, business risk, stakeholder attractiveness.
Criterion 1: consistency, especially with the mission and objectives
If the main purpose of the organisation is to add value, then the way that this is defined for the purposes of corporate strategy is through the organisation’s mission and objective –
In a non-profit-making organisation, the prime purpose may be better defined in terms of some form of service. Whatever the purpose of the organisation, a prime test of any option has to be its consistency: whether it is in agreement with the objectives of the organisation.
In a business context, this is likely to be the mission and its ability to deliver the agreed objectives of the organisation. If an option does not meet these criteria, there is a strong case for:
• either changing the mission and objectives, if they are too difficult or inappropriate;
• or rejecting the option.
If the mission and objectives have been carefully considered, then the rejection option is the most likely course. For example, the European consumer products company Reckitt Benckiser has a net revenue growth rate of 5–6 per cent for all areas of its business at constant exchange rates.5This means that strategy options that do not deliver this in the long term are rejected by the company. The qualification ‘in the long term’ relates to the fact that there may well be a period in the very early years of a new option when the project will fall short, but it must deliver over a longer period.
Criterion 2: suitability
In addition, some options may be more suitable for the organisation than others: how well does each option match the environment and resources and how well does it deliver competitive advantage? Suitability means to be appropriate for the context of the strategy of the organisation both internally and externally.
The environment can be explored from the mixture of opportunities to be taken and threats to be avoided. Competitive advantage can be built on the organisation’s strengths, especially its core competencies, and may try to rectify weaknesses that exist.
The SWOT analysis at the beginning of Chapter 13 summarises the main elements that have been identified here. Strategy options can also be examined for their consistency with the elements of the SWOT analysis. For example, Nokia mobile telephones have strengths in marketing to the main telecommunications distributors across Europe. A new option that ignored these strengths and pursued a policy of new mobile outlets, such as grocery supermarkets, would need careful study and possibly (but not necessarily) rejection. In fact, this option has been picked up with vigour because it represented a way for Nokia to extend its market penetration.
Criterion 3: validity
Most options will involve some form of assumptions about the future. These need to be tested to ensure that they are valid and reasonable, i.e. that they are logically sound and conform with the available research evidence. Validity means that the calculations and other assumptions on which the plan is based are well-grounded and meaningful.
In addition, many options will use business information that may be well grounded in background material or, alternatively, doubtful in its nature. For example, some of the information that Nokia has about its competitors is soundly based, e.g. the market share data, but some is likely to be rather more open to question, e.g. information on the future plans and intentions of Motorola.
For both the above, it will be necessary to test the validity of the assumptions and information in each option. In practice, there is some overlap between suitability and validity.
Because of the element of judgement in such issues, this is done under the general heading of applying business judgements and guidelines.
Criterion 4: feasibility of options
Feasibility means that the proposed strategies are capable of being carried out. Although options may be consistent with the mission and objectives, there may be other difficulties that limit the likelihood of success. An option may, in practice, lack feasibility in three areas:
1 culture, skills and resources internal to the organisation;
2 competitive reaction and other matters external to the organisation;
3 lack of commitment from managers and employees.
Constraints internal to the organisation
An organisation might not have the culture, skills or resources to carry out the options. For example, there might be a culture in the organisation that is able to cope with gradual change but not the radical and sudden changes required by a proposed strategy option. For example, the difficulties experienced by the highly centralised company Metal Box (UK) when it merged with the decentralised company Carnaud (France) were largely in this area and caused the group major problems.6
Equally, an organisation may lack the necessary technical skills for a strategic option. It may not be possible for a variety of reasons to acquire them by recruiting staff.
In addition, some organisations have insufficient finance for an option to succeed. For example, the French computer company Groupe Bull had real problems financing its strategic development during the mid-1990s as it struggled to survive after a series of over-ambitious strategy initiatives earlier in the decade.
Constraints external to the organisation
Outside the organisation, there are four main constraints that may make a strategic option lack feasibility: customer acceptance, competitive reaction, supplier acceptance and any approvals from government or another regulatory body.
Customers need to find a new strategy attractive. In addition, competitors who are affected by a strategy option may react and make it difficult to achieve. For example, the US software company Microsoft has around 90 per cent of the world market for personal computer software with its Windows operating system. In the past, it has been accused by competitors of deliberately pre-announcing some of its products to stall sales of new, competing software products. The likelihood of competitive response is an area that must be assessed.
There may also be other constraints outside the organisation that make strategy options difficult if not impossible. For example, Nokia had to consider carefully the implications of the reduction in government control over telecommunications markets. This was not only an opportunity but also a problem because governments were still sensitive over their national interests in this area.
Lack of commitment from managers and employees
If important members of the organisation are not committed to the strategy, it is unlikely to be successfully implemented. For example, the major US toy retailer Toys ‘ ’ Us had major problems implementing its business strategy in Sweden some years ago because the local managers and employees considered it to be inconsistent with the Swedish approach to labour relations.
This constraint may arise because some organisations make a clear distinction between strategy development by senior managers and day-to-day management by more junior managers. Hence in such organisations, junior managers and employees are unlikely to have been involved in the strategy development process: in essence, they have the results communicated to them and they may not feel committed to its implications.
Some strategic decisions may need to be made by a senior management centralised group – for example, the Nokia decision at the beginning of the 1990s to divest some companies. In spite of Nokia’s commitment to an open Finnish culture, the key decisions on the new strategy were taken by a group of senior managers. The more junior managers and employees were not really consulted. Since the proposals included divesting part of Nokia, this is not really surprising.
Criterion 5: business risk
Most worthwhile strategies are likely to carry some degree of risk. In this context, risk means that the strategy does not expose the organisation to unnecessary hazards or to an unreasonable degree of danger. Such areas need to be carefully assessed. Ultimately, the risks involved may be unacceptable to the organisation. There are countless examples in corporate strategy of organisations taking risks and then
struggling to sort out the difficulties. For example, Germany’s largest industrial company, Daimler-Benz, took considerable risks with its expansion strategy during the 1990s . In 1998, the company chose to merge with the US car company Chrysler, involving significant risk if the benefits were to be achieved.
It is easy to see business risk only as a major strategic constraint. The Japanese strategist Kenichi Ohmae comments that this may stop a company from breaking out of the existing situation. Yet some degree of business risk is likely in most worthwhile strategy development. The important aspects are:
• to make an explicit assessment of the risks;
• to explore the contingencies that will lessen the difficulties if things go wrong;
• to decide whether the risks are acceptable to the organisation.
There is no single method of assessing risk in the organisation, but there are a number of techniques that may assist the process.
Financial risk analysis
For most strategy proposals in both the private and public sectors, it is important to undertake some form of analysis of the financial risks involved in strategy options. There are a number of types of analysis that can be undertaken:
• Cash flow analysis. This analysis is essential. An organisation can report decent levels of profitability at the same time as going bankrupt through a lack of cash. Each option needs to be assessed for its impact on cash flow in the organisation.
• Break-even analysis. This is often a useful approach: it calculates the volume sales of the business required to recover the initial investment in the business. The important point about such a result is to explore whether this volume is reasonable or not – see
• Company borrowing requirements. The impact of some strategies may severely affect the funds needed from financial institutions and shareholders.
• Financial ratio analysis. Liquidity, asset management, stockholding and similar checks on companies can be usefully undertaken. It might be argued that they are not needed since the company should know in detail about these areas. But what about key suppliers? And key customers? The knock-on effects of bankruptcy in one of these, when the company itself is stretched financially, deserve consideration .
For international activities, there is one other area that is also important: currency analysis. A major shift in currencies can wipe out the profitability of an overseas strategy option overnight (or, more optimistically, increase it). A number of major companies have discovered the impact of this over the last few years. Specialist help may be required.
Scenario building
This is a most useful form of analysis and would be regarded as part of the basic strategy proposals in many organisations. Essentially, it explores the ‘What if?’ questions for their impact on the strategy under investigation. The basic assumptions behind each option, e.g. economic growth, pricing, currency fluctuation, raw material prices, etc., are varied and the impact is measured on return on capital employed, cash and other company objectives. The key factors for success may be used to identify the major points that need to be considered.
The sensitivity of each these factors, as they are moved up or down by arbitrary variations, is then assessed in order to determine which are crucial. Those variations that turn out to be particularly sensitive can then be re-examined carefully before the strategy is accepted. They can also be monitored after it has been put into operation. For example, the key assumptions of the Nokia mobile telephone expansion might be tested by examining what would happen if they varied:
• What impact would there be if Nokia carried on without the new rate of investment? This is quite specific and the result could be used to assess the strategy.
• What impact would there be if Nokia only limited cost savings as a result of its new plans? Perhaps only another 10 per cent cost savings instead of the 20 per cent assumed in the plan? Again a specific calculation could be undertaken to test the sensitivity of this change.
• What impact would there be if Nokia lost its market leadership? Perhaps the simplest calculation would be to assume that the three main companies – Nokia, Motorola and Ericsson – ended up with equal shares and the result was recalculated. The sensitivity to share variation could then be assessed. Clearly, the results of all sensitivity analyses can provide those selecting the strategies with a useful estimate of the risks involved.
Criterion 6: attractiveness to stakeholders
Attractiveness to stakeholders means that the strategy is sufficiently appealing to those people that the company needs to satisfy. As every organisation has its stakeholders, such as the shareholders, employees and management. They will all be interested in the strategic options that the organisation has under consideration because they may be affected by them. But stakeholder interests and perspectives may not always be the same. For example, an option might increase the shareholders’ wealth but also mean a reduction in employees in the organisation. Hence, stakeholders may not find all the strategic options equally attractive.
One way of resolving this issue is to prioritise the stakeholders’ interests – for example, by putting the shareholders’ interests first and raising dividends, cutting costs and possibly even sacking some workers.
Applying Empirical Evidence
There is also empirical evidence of strategies adopted by other organisations in the past that have succeeded or failed. Such evidence also provides guidance that can be used to select the optimal strategy from the options available.
Generic industry environments
Some strategies have been shown through logical thought to provide a higher chance of success than others. Such insights may aid the selection of strategy options. Exploration and understanding of the main concepts is called the study of generic strategy environments: this proposes that strategies can be selected on the basis of their ability to cope with a particular market or competitive environment. One of the best-known examples of this general approach is the ADL matrix. The well-known management consultants Arthur D Little (ADL) developed the matrix during the 1970s. It relies on matching an organisation’s own strength or weakness in a market with the life cycle phase of that market. Specifically, it focuses on:
• stage of industry maturity – from a young and fast-growing market through to a mature and declining market;
• competitive position – from a company that is dominant and able to control the industry through to one that is weak and barely able to survive.
It would be wrong to oversimplify the strategies that can be adopted depending on a company’s competitive position in the above. For example, if a company was in a strong position in a mature market, then the strategic logic of the matrix would suggest that it:
• sought cost leadership or
• renewed its focus strategy or
• differentiated itself from competition while at the same time growing with the industry.
Hence, if other strategy options for this market and competitive combination were presented and they did not conform with one of the above proposals, there would be a case for rejecting them. However, it will be evident that such analyses can be flawed where major technological change and marketing initiatives are introduced.
Profitability and three key strategic issues
According to some research evidence, profitability in commercial organisations is linked to three key strategic issues:
1 the role of quality as part of strategic decision making;
2 the importance of market share and marketing expenditure as a contributor to strategy development;
3 the capital investment required for new strategic initiatives.
The evidence in this area comes from the Strategic Planning Institute (SPI), located in the US. For the last 20 years, the SPI has been gathering data on about 3,000 companies (some 600 of which are located in Europe). The information collected covers three major areas:
1 the results of strategies undertaken (profits, market share, etc.);
2 the inputs by the company to this activity (plant investment, finance, productivity, etc.);
3 the industry conditions within which the company operates (market growth, customer power, innovation, etc.).
The data are often described as the PIMS Databank (PIMS is short for Profit Impact of Market Strategy), which is unique in the extent of its empirical database on corporate strategy coupled with its inputs and outputs. It collects data and calculates statistical correlations between various elements; whether such relationships have any real meaning has been the subject of fierce academic debate. This book takes the view that it has made a useful contribution to empirical strategy research. The overall results have been published and a few of the key findings are explored below. In addition to its general work, the results are also fed back to contributing companies on a detailed and more confidential basis for them to assess their performance and draw relevant conclusions. From the results of these extensive studies, three key factors emerge – namely: quality, market share and marketing spend, and capital investment.
Quality
In the long run and according to the PIMS Databank, the most important single factor affecting a business unit’s performance is the quality of its products and services, relative to those of its competitors. Strategy options that seek to raise quality are more likely to be successful than those that do not. Strategy options that consider quality in relation to the price charged are more likely to have a greater chance of success.
Market share and marketing expenditure
PIMS monitors market share and has shown a strong correlation with return on investment. It also monitors marketing expenditure, where the results depend on whether the company already has a high or low market share.
The PIMS evidence suggests that there is a correlation between high levels of marketing activity and market share. For those companies that already have a high share, there is merit in maintaining their levels of expenditure. For those companies with low market share, the correlation implies that it may not be the best strategy to spend funds on marketing activity to increase market share. Strategy options that attempt to buy market share with additional marketing activity may result in low return on investment.
However, it should be noted that the evidence is circular in the sense that, if high-share firms have higher profits, then they have more funds to invest in cost-saving devices, higher quality and more marketing activity. This will, in turn, raise their market share and profitability even further. Moreover, such evidence may be of little strategic help to the majority of companies that do not have a high share: what can they possibly do to catch up? It may be prohibitively expensive to invest in marketing and plant economies. However, Japanese car and electronics companies were in much that position in the 1960s, but have developed to become a major force in the world car industry. Innovation and the mistakes of the market leaders provide clues on the strategies needed.
Mergers and acquisitions
Mergers and acquisitions often form part of the strategy options that are expected to transform company performance. Although there are clear reasons for seeking mergers and acquisitions, the empirical evidence on their performance suggests that they add little value to the companies undertaking the activity.
Various researchers have concluded that: ‘. . . The typical effect of merger and acquisition (M&A) activity on firm performance has been well documented and, on average, M&A activity does not lead to superior financial performance . . . Despite decades of research, what impacts the financial performance of firms engaging in M&A activity remains largely unexplained’.
None of the evidence suggests that it is impossible for mergers or acquisitions to succeed in adding value. What the evidence does suggest is that many do not and the main reason would appear to be over-optimistic and vague objectives rather than some deeper inherent flaw. Generally, they are more likely to be successful where the partners are of similar size.
In addition, cost cutting and asset downsizing may not be the most effective ways of improving performance. It may be more useful to consider ways of transferring competencies and exploiting revenue synergies. Beyond this, such options have no proven record of success in terms of delivering value.
International strategy selection is more complex. The starting point is clarity on the objectives and reasons for international expansion. The difficulty in international strategy is to find some basic pattern and logic for such developments in order to facilitate their selection. There may be some conflict between corporate headquarters and the individual international operating companies as a result of different competitive pressures, differing customer tastes and different cultures.