UNIT 2 STRATEGIES AND MANAGEMENT CONTROL

Save this PDF as:
 WORD  PNG  TXT  JPG

Size: px
Start display at page:

Download "UNIT 2 STRATEGIES AND MANAGEMENT CONTROL"

Transcription

1 UNIT 2 STRATEGIES AND MANAGEMENT CONTROL Strategic and Objectives After studying this unit, you should be able to understand the: Concept of strategy Nature of corporate and business unit strategies Inter-linkages and interface between strategies and management control Structure 2.1 Introduction 2.2 Mission and Objectives 2.3 Concept of Strategy 2.4 Strategies and Core Competencies 2.5 Corporate Level Strategies 2.6 Business Unit Strategies 2.7 Strategies and : Interface 2.8 Radical Performance Improvement and s 2.9 Summary 2.10 Key Words 2.11 Self Assessment Questions 2.12 Further Readings 2.1 INTRODUCTION In the control hierarchy, the focus is on strategy formulation, management control and task control. Strategies indicate the general direction in which an organization is moving to fulfill its mission, goals and objectives, Hence, understanding the nature of competitive strategies is very important. There are a variety of models and frameworks which help us in understanding the concept of strategy. They also help us in formulation of strategies. In this unit we will deal with these models and frameworks. Since you will be studying about the concept of strategy in greater depth in the course on Strategic Management, in this unit, therefore, we limit ourselves to a general introduction of the concept of strategy and various models of strategy formulation. The basic idea in this unit is to understand the linkage between strategy and management control. 2.2 MISSION AND OBJECTIVES Goals are defined as "broad statements of what the organization wants to achieve in the long run on a permanent basis" and objectives are defined as " specific statement of ends, the achievement of which is contemplated within a specified time". Many times these terms are also used interchangeably. However; both are subsumed under the term mission, which is indicative of the `strategic intent' and `strategic direction' of the organization. Mission is articulated on the basis of the vision of the founders or the chief executive. Mission is achieved through a properly formulated strategy and 29

2 : Concepts and Context action plan with appropriately in-built mid-course correction system. Mission, vision and action indicate the interactive relationship between strategy and management control. In the case of business organizations, an important goal is the Return-on-Investment (ROI). The concept of ROI is defined as follows: Thus, ROI is a product of two factors viz. Profit margin in % terms and investment turnover. ROI can be improved either by increasing the profit margin or by increasing the productivity of capital by improving the turnover ratio or by improving both. As an illustration, consider the case of ABC with revenues as Rs. 50,000, expenses as Rs. 48,000 and investment as Rs. 10,000. Its ROI is as follows: 30 ROI can be improved either by increasing profit margin from the current level of 4% or by improving efficiency of usage of assets i.e. by increasing turnover ratio from

3 existing level of 5 or by improving both. But there will be other constraints such as business factors, managerial factors and environmental factors that would restrict the profit margin and turnover ratio. Strategic and 2.3 CONCEPT OF STRATEGY The idea of strategy can be traced to the Greek word `strategies' meaning "the general's art". Stanford Research Institute defines strategy as "a way in which a firm reacts to its environment, deploys its principal resources and marshals its main efforts in pursuit of its purpose". It may be observed that "Pursuit of Purpose" is a key word in this definition. Therefore, for strategies to be meaningful, a firm should articulate its Purpose. The concept of corporate strategy was initially formulated by Kenneth R. Andrews: Strategy formulation is a process that senior executives use to evaluate a company's strengths and weaknesses in the light of the opportunities and threats present in the environment and then decide on strategies that would fit the company's competencies with environmental opportunities. In this concept, SWOT analysis is at the heart of strategy formulation. In SWOT analysis focus is on company's strengths and weaknesses and on the opportunities and threats coming from environment/ competition. SWOT analysis is an exercise in `internal analysis' i.e. identifying strengths and weaknesses and `environmental analysis' i.e. identifying opportunities and threats. Once this is done, appropriate strategies are formulated to achieve a fit between the organization and environment. Thus, strategy formulation is essentially a "fitting" process to find appropriate fit between organization and environment. There are four "fitting" responses. Figure 2.1 presents these responses. A discussion on these responses is as follows: Response I Matching strengths with environmental opportunities: This calls for an aggressive approach to strategy because the company has many strengths and many opportunities. If these opportunities are not tapped, they would become missed opportunities. Response II Coping with threats from the position of strength: When the company has several strengths but it faces a number of threats, the response strategy is one of diversification. Through diversification it can minimize the adverse impact of threats Response III Market offers opportunities but the company has several weaknesses: In such a situation, company should be put into a turnaround gear. It should focus on overcoming its weaknesses so that it can tap the opportunities to its advantages. Response IV There are many threats and the company has several weaknesses: This is the case of losing battle. Company can focus an protecting its territory through a defensive approach. Unless a `strategic surgery' is done, company will have to divert and say quits to the business. 31

4 : Concepts and Context SWOT analysis is a useful tool for positioning the company with respect to the environmental conditions. This analysis can also be applied to the product-market strategies. Products have their strengths and weaknesses, markets offer opportunities and threats. There are four positioning strategies: 1) Product has many strengths and Market offers opportunities: Skim the market, increase the market share. 2) Product has strengths but Market is full of threats: Highlight the product's strengths to maintain the market share. 3) Product has weaknesses but Market offers opportunities: Improve the product to the requirements of the market. 4) Product has weaknesses and Market has threats: This is an ICU (Intensive Care Unit) syndrome. Be prepared to say quits both to the product and to the market. 2.4 STRATEGIES AND CORE COMPETENCIES The idea of core competence was formulated by Prahald and Hammer in their article, "Core Competence of the Corporation". "A core competence is what a firm excels at and what adds significant value for customers". From this definition of corecompetence, it may be observed that core competence essentially means strengths of the company. Thus, the concept of core competence draws our attention to the first factor of SWOT analysis i.e. the strengths factor. "Strategy should be based on strength", is an ancient quote, used in the context of war between two kingdoms. In competency-based strategy, we find an echo of this ancient wisdom. The idea of core competence when matched with the opportunities and threat analysis, provides a contour for strategic directions for the organization. Herein lies the importance and usefulness of the idea of core competence. Since different organizations possess different core competencies, each organization must identify its core competencies and build them further for matching with market opportunities and overcoming the market threats. Activity 1 32 a) Explain the concept of ROI

5 b) Define the meaning of the word strategy? c) Explain, what is SWOT analysis? d) Define "core competence". In what ways is it linked with SWOT analysis? CORPORATE LEVEL STRATEGIES Strategic and It has been said that, "A new strategy sometimes succeeds and may sometimes fail. Unless we try it out we will not know about its success or failure". This wis ' dom of the practitioners is important in formulating strageties. Strategies help us in identifying the "general direction in which an organization plans to move to achieve its mission, goals and objectives". The general direction is indicated by the portfoliomix of the businesses. Why the current portfolio mix should change? What should be the new portfolio mix? These are the questions of importance in formulating Corporate Level Strategy. In the case of army, strategy implies "deployment of resources". Similarly, in corporate level strategy, the key idea is about the "deployment of resources" and the choice of "right mix of businesses" including the right choice of the "basket of products" At the corporate level, the strategy issues involve the following decisions: Remain a single industry firm Diversify in related businesses Diversify in unrelated businesses A single industry firm operates in one line of business. Many IT industry firms are single industry firms, for example, Infosys. A related diversified firm has business units in related businesses, while in unrelated diversified context, firm operates in very diverse businesses. Tata and Birla are often cited as business houses (conglomerates) that have in their portfolio mix, a number of unrelated businesses. All the three types of firms can be observed in real life. Each has its own advantages and disadvantages. Research has yet to conclusively prove the efficacy of one type over the other, in terms of value to shareholders and value to stakeholders. The advantage of related diversification lies in firm's ability to transfer its core competencies from one set of business to another. In conglomerates, such flexibility in transfer of core competencies is not easily available because the businesses and their core competencies are not inter-related. Complete autonomy to businesses is an 33

6 : Concepts and Context effective way of running such businesses. In Birla organizations, such an autonomy is ensured through a "Padta system", wherein only cash flows are monitored and complete autonomy is given for decision making to the chief executive of the respective. businesses. It may be indicated that core competencies can be classified in following two categories: Transferable core competencies Non-transferable core competencies In case of single industry firm, core competencies are easily transferable from one business unit to another, from one location to another. In case of related diversified firm, core competencies can also be transferred from one business unit to another. However, in case of non-related diversified firms, it becomes difficult to transfer core competencies across the entire business spectrum. Transferability of the core competencies provides flexibility to corporate management to respond well to the opportunities and threats. 2.6 BUSINESS UNTT STRATEGIES While strategies are formulated at the headquarters, battles are fought at the field. This metaphor has implications for the business organizations. Corporate level strategies determine the overall strategic direction of the organization, the battle for survival and market shares takes place at the level of the business units. Therefore, business unit mission and business unit strategy assume significance in the overall scheme of things. Business units of an organization have to face the "competition heat" at the market place. In case of single industry firm, the heat of competition is felt both at the corporate level and the business unit level. In case of diversified firms intensity of competition heat is felt more at the business unit level. In both situations, business units must gear itself to face the competition. In essence, it should focus on creating a competitive advantage for itself. The following models help us in formulating business unit strategies: The BCG Model BCG (Boston Consulting Group) model is an important analytical tool for anlyzing the business unit strategies. The model provides a 2 x 2 matrix based on market share and market growth as a criteria to classify various businesses. The model not only classifies the business but also identifies the strategies for each category. Figure 2.2 presents the BCG model. 34

7 The following are the metaphors used in BCG matrix to classify various businesses: 1) High market share, high market growth Star Strategic and 2) High market share, low market growth - Cash cow 3) Low market share, high market growth - Question mark 4) Low market share, low market growth Dog It may be indicated that BCG matrix is essentially an extension / application of SWOT analysis to product and markets. High market share and low market share are indicative of the strengths and weakness of the company and high market growth and low market growth are indicative of the opportunities and threats. BCG matrix suggests that if a company/business unit is in "star" position, the strategy should be to hold on to this position. This is referred to as "hold" strategy. If company is in a "cash cow" position, it should milk the cash cow. This is referred to as "harvest" strategy. If company is in "question mark" position, it should try to increase the market share. This is referred to as "build strategy". If the company is in "dog" situation, it should think of getting out of such a business. This is referred to as "divest strategy". General Electric (GE) Planning Model The General Electric Planning model considers business strength and industry attractiveness as criteria for categorizing businesses. This model uses a 3 x 3 matrix for classifying businesses in terms of categories such as winners, question marks, average businesses, profit producers and losers. The model is presented in Figure 2.3. When we compare the GE model with BCG model, we can observe that market share is indicative of the competitive position or business strength and market growth rate is indicative of the attractiveness of the industry. In fact, we can reduce 3 x 3 matrix of GE model into a 2 x 2 matrix and refer It as modified GE model. The model is presented in Figure

8 : Concepts and Context Improving Competitive Advantage An important aspect of business unit strategy relates to improving competitive advantage. For this Porter's five force model is useful to get an understanding of the industry structure. The five forces identified by Porter are as follows: 1) "The intensity of rivalry among existing competitors. Factors affecting direct rivalry are industry growth, product differentiability, number and diversity of competitors, level of fixed costs, intermittent over capacity, and exit barriers. 2) The bargaining power of customers. Factors affecting buyer power are: number of buyers, buyer's switching costs, buyer's ability to integrate backward, impact of the business unit's product on buyer's total costs, impact of the business unit's product on buyer's product quality/performance, and significance of the business unit's volume td buyers. 3) The bargaining power of suppliers. Factors affecting suppler power are number of suppliers, supplier's ability to integrate forward, presence of substitute inputs, and importance of the business unit's volume to suppliers. 4) Threat from substitutes. Factors affecting substitute threat are relative price/ performance of substitutes, buyer's switching costs, and buyer's propensity to substitute. 5) The threat of new entry. Factors affecting entry barriers are capital requirements, access to distribution channels, economies of scale, product differentiation, technological complexity of product or process, expected retaliation from existing firms and government policy". Porter's five force model is presented in Figure Figure 2.5: Porter's Five Force Model

9 The intensity of these forces is indicative of the attractiveness of the industry and competitive pressures within the industry. The five force analysis helps us in focusing our attention on the opportunities and threats in the external environment. Porter suggests two strategies for responding to the opportunities and threats, viz., cost leadership and differentiation. Strategic and In cost leadership route to competitive advantage, the focus is on gaining competitive advantage through cost advantage. If per unit costs are low because of the economies of scale, cost control, experience, curve advantage, etc., then the firm gains a cost advantage at the market place. In product differentiation route to competitive advantage, the focus is on differentiating the product in terms of product features, product design and product identity. The idea is to "create something that is perceived by customers as being unique". In the third route to competitive advantage, both the cost leadership and product differentiation are combined together. This route to competitive advantage is referred to as cost-dum-differentiation because it combines both the cost advantage and the product differentiation advantage. Hence, it represents the most attractive competitive position. Activity 2 a) Explain the basic idea behind BCG matrix. b) What is the difference between GE Planning model and BCG matrix? c) Identify the forces of Porter's five force analysis of an industry and offer your comments. 2.7 STRATEGIES AND MANAGEMENT CONTROL: INTERFACE There is a close interface between strategies and management control. This interface is indicated by the concept of "interactive control" formulated by Simons (1995). Control system is essentially a strategy implementation tool. When viewed from this perspective, strategy and control systems are coupled with each other. Information generated from the control system is useful in formulating new strategies. When control system generates meaningful and useful information for thinking about new strategies, such a control system is referred to as "interactive control". The information from such a control system has a learning value for the managers and the organization as a whole. 37

10 : Concepts and Context Because of "strategic uncertainties" such as changes in technologies, competiton, lifestyles, Customer preferences etc., it is important that control system should throw up information relating to indicators of strategic uncertainties and indicators of troubles. Then such a control system has learning value for all the employees leading to a proper "learnign environment". Such a control system also makes the organization a "learning centre". Thus a strong interface between the strategy and control system makes the organizations learning organization. The learning loop between strategy and control system is depicted in Figure 2.6. Activity 3 a) Explain the idea of "interactive control" given by Simons. d) How control systems can make an organization a "learning organization". 2.8 RADICAL PERFORMANCE IMPROVEMENT AND MANAGEMENT CONTROLS The idea of Radical Performance Improvement (RPI) has been suggested by Sumantra Ghoshal et. al., in their book, Managing Radical Change. They consider managerial function as "learning to cook sweet and sour". For achieving radical improvements in performance, managers should effectively manage the sour task of improving resource productivity and the sweet task of creating and exploiting new opportunities. In a way, this approach is similar to Simons "interactive controls" wherein strategy and control systems are coupled to generate the synergy. While control systems could represent the sour side, strategy represents the sweet side, as it involves looking for opportunities. However, at times, strategy could also go sour. If both control system and strategy go sour, there will be catastrophic under-p rformance leading to sickness. 38 In the RPI framework, three stages of competition have been identified, viz. Competition for dreams, Competition for the resources and competencies and Competition for markets. Competition for dreams involves articulating vision for future markets, indicating the corporate ambition and providing an overall sense of purpose to the business. Competition for resources and competencies includes competition for technology, quality people, brands etc. Competition for markets implies articulation of competitive strategy through industry analysis, segmentation and positioning, cost leadership and product differentiation, etc. Figure 2.7 presents this framework.

11 Strategic and For translating the framework of Radical Performance Improvement into an action plan, resources and competencies should be matched with business and opportunities. This is similar to the SWOT analysis, wherein strengths and opportunities are matched. Strengths are indicative of the resources and competencies, while opportunities implies "baskets of businesses". Existing resources and competencies could be expanded by adding new resources and competencies. Similarly, an organization could look for new businesses and new opportunities. RPI framework suggests that managers should leverage the existing and new resources and competencies by exploiting the existing and new markets and opportunities. Figure 2.8 presents this approach. Source: Ghoshal et.al., Managing Radical Change, 2000, Penguin Books, p.87 Through the case studies of Indian companies, Ghoshal et.al., suggest many innovative ways of "cooking sour and sweet" to achieve a breakthrough in performance. They also suggest a fundamental shift in management thought from 3Ss to 3Ps, wherein 3Ss stand for Strategy, Structure and Systems and 3Ps stand for Purpose, Process and People. In fact, we need an integrative approach wherein 3Ss and 3Ps play a complementary role. They should not be in contradiction to each other but should mutually support each other. We present this integrative approach in Figure

12 : Concepts and Context In effective organizations, interaction between three Ss and three Ps is managed to achieve a synergy between them, thereby ensuring radical performance Management Control Systems should be designed to facilitate this interaction. Herein lies the linkage between Radical Performance Improvement (RPI) and the Management Control Systems (MCS). Activity 4 a) Which are the three stages of competition suggested by Ghoshal et. al.?... b) Identify the three Ss and three Ps in the RPI model and highlight their importance for radical performance improvement SUMMARY Concept of strategy is fundamental to survival and growth of an organization. Strategies should be well articulated in consonance with Purpose, Mission, Goals and Objectives. SWOT analysis is an important analytical tool that managers use in formulating strategies. BCG matrix and GE planning model, are analytical models for deciding about the "basket of businesses" or "basket of products" that a business entity should carry in its portfolio. Porter's five force model is alse helpful in analyzing the attractiveness of an industry. These models help managers in concretizing their business strategies. Interface between strategies and management control can be strengthened through "interactive controls". This in turn can make an organization as a "learning organization". The unit concluded with the concept of Radical Performance Improvement and role of control systems in facilitating Radical Performance Improvement KEY WORDS Goals: Broad statements of what the organization wants to achieve in the long run Strategy: A way in which a firm reacts to its environment deploys its resources and marshals its main efforts in pursuit of its purpose. SWOT Analysis: An analytical tool for strategy formulation indicating Strengths, Weaknesses, Opportunities and Threats. 40 Core Competence: A core competence is what a firm excels at and what adds significant value for customers. BCG Matrix: A 2 x 2 matrix based on market growth and market share. It classifies

13 business in terms of "stars", "cashcows", "question marks" and "dogs" GE Planning Model: A 3 x 3 matrix based on industry attractiveness and business strength for classifying businesses in various categories. Strategic and Interactive Control: When control system generates meaningful and useful information for thinking about new strategies such a control system is referred to as "interactive control". Three Stages of Competition: Competition for Dreams, Competition for Resources and Competencies and Competition for Markets and Opportunities SELF ASSESSMENT QUESTIONS 1) Define the concept of strategy. Show how SWOT analysis is used in formulating strategies. 2) Explain the BCG model, highlighting its usefulness in formulating business unit level strategies. 3) Explain Porter's five force model and its importance for strategy formulation. 4) How can interface between strategies and management controls be strengthened? 5) Explain the concept of Radical Performance Improvement (RPI) and the role of Systems in facilitating RPI FURTHER READINGS Andrews, Kenneth R, 1980, The Concept of Corporate Strategy, Richard D.Irwin. Anthony, R.N. and Govindrajan V, 1994, Systems, Tata McGraw Hill (Chap.2). Ghoshal, Sumantra Gita Piramal and Christopher A Bartlett, 2000, Managing Radical Change: What Indian Companies Must Do To Become World-Class, Penguin Books (Chap. 4&14). Merchant, Kenneth A 1998, Modern Systems: Text and Cases, Prentice Hall. Porter Michael, 1985, Competitive Advantage, The Free Press. Sharma, Subhash 1988, Systems, Text and Cases; Tata McGraw Hill (Chap.2). 41