Definitions, Content, Purpose, Meaning Explained
BusinessEncyclopediaISBN09.Updated 2018-06-202018 Solution Matrix Ltd
Company business strategy explains how a firm differentiates itself from competitors, how it generates revenues, and where it earns margins.
Business strategyis sometimes defined only as a firms high-level plan for reaching specific business objectives. Strategic plans succeed when they lead to business growth, a strong competitive position, and strong financial performance. When the high-level strategy fails, however, the firm must either change its approach or prepare to go out of business.
The brief definition above is accurate but, for practical help, many businesspeople prefer instead a slightly longer explanation:
Business strategyis the firms working plan for achieving its vision, prioritizing objectives, competing successfully, and optimizing financial performance with its business model.
The choice of objectives is the heart of the strategy, but a complete approach also describes preciselyhowthe firm plans to meet these objectives.As a result, the strategy explains in practical terms how the firm differentiates itself from competitors, how it earns revenues, and where it earns margins.
Strategies Reflect the Firms Strengths, Vulnerabilities, Resources, and Opportunities. And, They also Reflect the Firms Competitors and Its Market.
Many different strategies and business models are possible, even for companies in the same industry selling similar products or services. Southwest Airlines (in the US) and Ryan Air (in Europe), for instance, have strategies based on providing low-cost transportation. The approach for Singapore Airlines focuses instead on brand imagefor luxury and quality competitive industries, each firm formulates a strategy it believes it can exploit.
In business, strategy begins with a focus on the highest level objective in private industry:Increasing owner value. For most companies, in fact, that is the firms reason for being. In practical terms, however, firms achieve this objective only by earning profits. For most firms, therefore, the highest goal can be stated by referring to profits. The generic business strategy, therefore, aims first toearn, sustain, and grow profits.
Strategy discussions are sometimes confusing because most firms, in fact, havemanystrategies, not just a single business strategy. Analysts sometimes saymarketing strategywhen they, in fact, mean the firmscompetitive strategy. And, a firmsfinancial strategyis something different from itspricing strategy, oroperational strategy. The firms many strategic plans interact, but they have different objectives and different action plans.
The subjectbusiness strategyis easier to understandto make coherentby viewing each one as part of astrategic framework.
The strategic framework is a hierarchy. At the top sits the firmsoverall(orgeneric)business strategy. Here, the aim is the highest-level business objective: earn, sustain, and grow profits. Some may immediately ask: Exactlyhowdoes the firm achieve its profit objectives?
Firms in competitive industries answer the how question by explaining how the firmcompetes. For these firms, therefore, the overall business strategy is rightly calledcompetitive strategy. A competitive strategy explains in general terms how the firm differentiates itself from the competition, defines its market, and creates customer demand.
However, detailed and concrete answers to the how question lie in lower level strategies, such as the marketing strategy, operational strategy, or financial strategy, The marketing strategy, for instance, might aim to Achieve leading market share. Or, Establish leading brand awareness. Financial strategy objectives might include: Maintain sufficient working capital or Create a high-leverage capital structure.
Indeed, most firms develop and use a rich and complex strategic framework. As a result, business strategy formulations are more explicit when they focus on these points:
Specific business objectives for each strategy
. Identifying which goals in the framework have priority over others.
Mapping relationships between the various strategies
. Showing, for example, which of them support others.
This article, therefore, presents business strategies as components of a strategic framework.
This article further explains and illustratesbusiness strategyin the context of related terms such as the following:
Purpose of the Strategy: How do you know the strategy serves its purpose
Strategy and the meaning of success.
How do firms know when to change strategies?
How do they know if the new plan succeeds?
How do you formulate a business strategy? Formulating a general business strategy in five steps.
Secondly, focus on the most critical objectives.
Thirdly, plan the attack, choose the battlefield.
Fourthly, take a reality check: Does the business model stand?
Fifthly, build a support structure: The strategic framework.
Brand, branding process, and branding strategies: SeeBranding.
Pricing, pricing objectives, and pricing strategies: SeePricing.
Company profitability metrics. SeeProfitability.
Capital and financial structures. SeeCapital Structure, Financial Structure, and Leverage.
Purpose of the Strategy: How do you know the strategy serves its purpose?
Strategies and the Meaning of Success
Business strategies succeed when they lead to business growth, strong competitive position, and strong financial performance. Many different approaches are possible, but all are meant to bring improvements in these areas.
Inhighlycompetitive industries, the firms officers and other senior managers take a keen interest in knowing precisely how well their strategies succeed in serving this purpose. Interest is especially keen immediately after the company changes or adjusts plans.
In 2009, for instance, managers and owners of Dominos Pizza, Inc. were diatressed because the firm had just had three years of negative sales growth and shrinking market share. The firm was, in particular, losing market share to two significant competitors, Papa Johns and Pizza Hut.
Dominos operates in the Quick Service Restaurant (QSR) industry. Many people call this industry, unkindly, the Fast Food business. The firm competes not only with other Pizza restaurants, but also with restaurants with different menus such as Subway, McDonalds, and Chick-Fil-A. This segment of the Restaurant industry defines itself not by menus, but instead by the words Fast and Quick. Understandably, therefore, Dominos started with a strategy based on Quick Service Delivery. The firm excels in fast delivery, a point that separates Dominos from its competitors. Nevertheless, in 2009, the strategy seemed to be failing.
In late 2009, therefore, the firms new CEO chose to re-center strategy on pizzaquality. Market research showed that customers rated Dominos pizzatasteas very poor (like cardboard). As a result, by the end of 2009, the firm had substantially improved the pizza recipe and launched a marketing program to bring this news to the market. The question on January 1, 2010, was: Will the new strategy work?
Anxious for an answer, the firm began in Q4 2009 detailed tracking of the growth, competitive, and financial metrics that appear in the next section. By the end of Q1 2010, the first results were in. The measures in all three categories showed remarkable improvement. Dominos took this as confirmation the new strategy was succeeding.
Now in 2018, the firm continues to research and improve the pizza recipe, while adjusting its marketing strategy at the same time. For this, the firm relies on its 8-year tracking history with these metrics.
A new strategy or a strategic change is successful when the strategic plan itself is undoubtedly responsible for one or more of the following measurable, tangible results:
Notice that analysts measure the impact on financial performance with metrics that focus on the firmscore line of business.
Dominos, for instance, prefers to measure strategic impact with EBITDAEarnings before interest, taxes, depreciation, and amortization. Dominos tracks EBITDA because EBITDA (and other selective income metrics measure strategic effects more precisely than overallNet Income After Taxes.
The firms strategy drives performance in the core line of business, after all, and that is what strategic planners need to measure. Bottom line Net income, however, also reflects factors other than core strategy: (1) revenues and expenses from outside the core business, (2) accounting conventions such as depreciation, and (3) taxes. These factors tend to muddy the waters when the analyst tries to use Net Income to measure the impact of strategy changes.
Five Steps to a Generic Business Strategy
Business strategyis the firms working plan for achieving its vision, prioritizing objectives, competing successfully, and optimizing financial performance with its business model.
Strategy builders can find practical guidance in this definition. Notice that the definition names four kinds of actions. With just a little imagination you can probably see that these actions point rather directly to steps in a strategy building process:
Exhibit 1. Formulating a generic competitive strategy in five steps.
This strategy building process is rational, straightforward, and likely to succeedif the strategy builder takes these steps in order.
Note that businesspeople rightly speak of strategy building asstrategy formulation, instead of writing a strategy. The verbformulatesuggests a building process that is methodical or systematic and results that aredefinitiveandprecise.
Successful strategies build on the foundersvisionfor the business. For some firms, founders write a formal vision statement. Others list the core ideas that give the business substance, shape, and direction.Either way, the vision pictures the essential nature of the business: what it looks like and what it does.
Strategy formulation Step 1 lays a foundation for the strategy. Here, the strategy builder re-states several ideas from the founders vision for the business.
The business strategy builds directly on the firmsofferingsand itsvalue proposition. This proposition describes thegoods and services the firm sells,regarding the value they offer to the customer.
For instance, Dell began in 1984 with a value proposition that was unique at the time.Dell promised to build a computer when a customer orders, exactly as the customer wants it, and deliver it at a very competitive price.
For example, Boeing states the customer value proposition for its 747-8 aircraft very briefly: …more range, better fuel efficiency, and lower operating costs.
In brief, the value proposition explainswhycustomerswould buy from this firminstead of the competition. In this way, the value proposition shows how the firm creates customer demand and differentiates itself from competitors.
Naming the firmsindustry sectorhelps identify the firms competitors. And from that, the strategy builder learns which strategies the firm must compete against in the marketplace. The strategy builders task is to understand which approaches work well in the industry and which do not.
For example, Dominos Pizza operates in the Quick Service Restaurant industry. That means its competitors are restaurants of various kinds that:
When Dominos changed strategies in 2009, it did so after reviewing the approaches of its competitors, Papa Johns, Pizza Hut, Subway, Chick-Fil-A, McDonalds, and others.
Note that a single firm can operate in several industries. Apple, for instance, operates in at least five industry sectors: Computer hardware, Computer software, Consumer electronics, Digital distribution, and Silicon Design. Apple faces a different set of competitors in each of these industries.
There are, incidentally, quite a fewindustry classification schemes, or taxonomies, in use, worldwide. However, for strategy builders, all that matters is that the firm refers to a system that identifies the firms competitors accurately.
Identify first the firms customers as eitherconsumersorbusinesses. This distinction is essential for strategy builders because consumers and business firms buy for different reasons. They have different criteria for deciding what and when to purchase. And, they respond differently to seller pricing strategies.
Identify also thetarget marketfor the firms offerings and value proposition. Note that markets can have quite a few defining characteristics.
When customers are consumers, marketers define the market with factors such as gender, age,occupation, economic status, work experience, education, geographic location, or special interests.
If, however, the firm sells to other businesses (business-to-business, or B2B), it may define its market by factors such as customer industry, customer business model, or manner of selling.
Businesspeople sometimes ask: What is the purpose of the strategy? The answer has to name a businessobjective. The strategys reason for being, in fact, is to explain how the firm achieves specific goals.
Strategy formulation continues in Step 2 by naming tangible top-level of business objectives and explaining how to measure progress towards meeting them.
The generic business strategy explicitly addresses the firms most important goals. As a result, Strategy formulation Step 2 is a matter of specifying the firms highest level objectives.
For firms in private industry, the highest level objective is increasing owner value. For most businesses, in fact, that is the firms reason for being. Note, however, that firms achieve this objective only byearning profits. And, there are only two ways they can use the periods profits to increase owner value:
Firstly by distributing some or all profits directly to shareholder owners as
Secondly, by keeping some or all profits as retained earnings, thereby building owners equity on the Balance Sheet.
Because firms increase owner value primarily by earning profits, the supreme goal itself reduces to a profit statement: The firms primary objective is to make, sustain, and grow profits. From this, it follows that a private firms general business strategy is explicitly designed to enable the business to create, continue, and increase profits. Top Level Objectives in Government or Non-Profit Organizations
Most government and non-profit organizations, of course, do not exist to meet profit objectives. A fewsuch as Postal Services, licensing agencies, or lottery commissionsdo generate revenues and try to earn enough to cover their expenses. However, for these and all other government and non-profit firms, critical strategic objectives derive frommission statements.
For instance, the Department of Transportation in the US State of Oregon (ODOT) has the following mission statement:
ODOT Mission: To provide a safe, efficient transportation system that supports economic opportunity and livable communities for Oregonians.
From this, ODOT derives five critical strategic objectives: (1) Safety, (2) Mobility, (3) Preservation, (4) Sustainability, and (5) Stewardship. ODOT further explains the meaning of each objective in concrete terms. And, it provides tangible performance measures for each goal, which are useful for developing the Departments strategy. In this way, performance measures also help set targets, plan budgets, and evaluate Department performance.
Some businesspeople are not pleased when they think they have just heard that their firms only objective is earning profits. They are displeased because many firms have mission statements, value statements, and creeds that point to still higher objectives. People understandably ask whether strategy builders should place these objectives on the same high-level as the profit objective.
Consider, for instance, thecredofor Johnson & Johnson, a producer of medical devices, pharmaceuticals, and packaged goods. The J&J credo presents four responsibilities:
Our first responsibility is to the doctors, nurses, and patients, to mothers and fathers and all others who use our products and services.
Secondly, we are responsible to our employees, the men, and the women who work with us throughout the world.
Thirdly, we are responsible to the communities in which we live and work and to the world community as well.
Our final responsibility is to our stockholders.
The firm takes these responsibilities seriously. J&J displays the credo prominently in corporate buildings and on corporate grounds. And they emphasize these values in communications and reports. J&J describes them as values that guide our decision-making. As a result, the firm tracks its success in meeting these responsibilities with surveys and performance indicators.
Their importance notwithstanding, high-level mission statements and values like these arenotpart of the firms generic business strategy. They do not use these values to differentiate themselves from competitors. For that, J&J relies on a Broad differentiation strategy to distinguish itself from competitors and create customer demand. The set of values, on the other hand, help shape the ways the firm designs and implements lower-level strategies, such as its marketing strategy or its operational strategy,
Plan Your Attack and Choose Your Battlefield
Forfirmsincompetitive industries, the high-level generic strategy is necessarily acompetitivestrategy. In most cases, the selected approach results from two choices. The strategy builder must choose:
Firstly, a plan of attack, which is the general approach for differentiating the firm and its offerings from the competition.
Secondly, the battlefield, which is the specific market and market focus where competition takes place.
Strategy formulation Step 3 addresses the How question: Exactly how does the company achieve objectives? For firms in competitive industries, the question becomes this: Specifically, how does the company win against competitors, create customer demand, and earn, sustain, and grow profits? For these firms, the generic business strategy is acompetitive strategy.
For many decades, textbooks and business articles have put forward the idea that strategic planners have essentially only two possible plans of attack: Firstly,differentiationand secondly,cost leadership.
Here, the firm provides uniquely desirable products and services. Firms that choose a differentiation strategy to create and communicate uniqueness through one or more of the following::
Adding unique features or capabilities to existing products
Achieving brand strength, communicating desirability, exclusiveness, superior design, or high quality.
Pricing to undersell the competition.
Secondly, They May Choose Cost Leadership
Firms that pursue cost leadership goals minimize their production and selling costs. Companies with a cost leadership strategy can charge industry average prices and still earn handsome profits because their costs are lower than the competition. However, firms using cost leadership may also add an element of differentiation by selling at lower prices. Even so, they can still realize acceptable margins because their costs are low.
Discussions on business strategy usually refer to several ideas of Michael Porter. These stem primarily from Porters books,Competitive Strategy1(1980) andCompetitive Advantage2(1985). Porters approach adds a second choice for strategy builders: the scope of the attack against competitors.
Porters system allows strategy builders to select between attack plans Differentiation and Cost leadership, but also to choose the level of market scope for competitive activities. The strategy may target a broad market, or it may target a narrowly focused market.
As a result, under Porters system, the strategy builder chooses from four generic competitive strategies. Exhibit 1 shows the possibilities.
In competitive industries, each firm chooses the strategy it believes it is best prepared to exploit. Making that judgment, however, calls for excellent and detailed knowledge in several different areas.
Strategy builders, in other words, need access to information about their firmsome of which is public, and some of which is probably proprietary, or inside information.
might include, for instance, the firms capabilities in design, research, development, service delivery, or efficient production. Other advantages might involve existing market presence, strong branding, or effective sales and marketing.
might include specific weaknesses, inabilities, or ongoing problems. The firm might be struggling with cash flow problems and a shortage of working capital. Or, it may operate with a high-leverage capital structuremaking it vulnerable to business slowdowns or other changes in the economy. Or, the firm may be unable to bring new products to market quickly.
might include, for example, existing production capacity and the infrastructure to support it, or existing service delivery capabilities. Resources might also include access to capital, or sufficient working capital for product research and development, marketing programs, or infrastructure upgrades.
in the form of a failing competitor, or an expanding market, or an idea for an entirely new product.
Secondly, the Strategy Builder Tries to Understand the Firms Competitors and Their Strategies.
The strategy builder identified the firms industry in Step 1 (Build on the vision). Naming the industry sector helps identify the firms competitors.
Understanding the competition begins by identifying which competitors hold a significant share in the firms target markets.
It is essential to know which of these are gaining market share, losing market share, or merely holding market share.
From this, the strategy builder finds which strategies are working in this market, and which are not.
Incidentally, firms cannot hide their generic strategies from competitors. One firm can reasonably deduce the strategic plan of another from knowledge of the competitors product history, pricing history, and marketing messages.
In Step 1 (Build on the vision), the strategy builder also states the firms offerings, its value proposition, its target customers, and its target market.
The strategy builder will try to understand first the buying behavior of the firms customers by understanding what defines value for these customers: They may shop for price, for the brand, or they may judge value by other criteria.
Understanding the dynamics of the target market will also be necessary for Step 5 (Reality check: Does the business model stand?). For this, the strategy builder needs to know, especially, market size and market growth rate.
Strategy Exists When the Business Model Exists
Knowledge in the above areas may be considered the necessary background for choosing and building a strategic plan. From this, strategy builders sense intuitively which general strategy will serve the firm best. And they may at this point have some sense of how the firm will differentiate itself and create customer demand. This much, however, is not yet a strategy.
The strategy builder must now use the background information to turn these judgments into a quantitativebusiness model.
Reality Check: Does the Model Stand?
Thestrategywillbeready to go to market only after it validates with a quantitative business model.
Strategy formulation Step 4 completes the general business strategy by developing the business model inherent in the strategic plan. Here, the challenge is to build a quantitative model, implied by the approach, that is realistic and credible.
The Model Serves As a Reality Check For the Generic Strategy.
For this, the strategy builder uses the background knowledge from Step 3 along with realistic sales and cost assumptions to build a quantitative business model. The resulting model shows whether or not a proposed strategy can bring desirable sales revenues, margins, and profits.
The Model Also Serves As a Basis for the Firms Business Plan
When the firm chooses to implement the strategy, the model becomes the cornerstone of the firmsbusiness plan. In that capacity, the model also supports forecasting of sales revenues, costs, margins, and profits.
In its purest form, the business model looks like a very brief version of the firms Income statement. Like the Income statement, the model starts with sales revenues. Estimated expenses are subtracted from these to create margins and profitsgross profit, gross margin, operating profit before taxes, and operating profits and margin after taxes.
Exhibit 2 shows two models, from two different firms, each with its generic strategy. Figures are in $1,000s.
Exhibit 2. Business models for firms Alpha and Beta. Each firm develops its model from its generic strategy proposal. The models rely on sales and cost assumptions they believe are reasonable.
Before comparing the Alpha and Beta models, it will be helpful to discuss briefly how the strategy builder creates the model from a strategy proposal and the Step 3 background information. The quantitative model with profits and margins develops naturally when the strategy builder makes these estimates:
Firstly, target product revenues and target services revenues.
Secondly, expenses necessary to earn target revenues in these expense areas:
Cost of Goods sold and Cost of services.
Administrative and general overhead expenses.
Forecasting Target Revenues for the Model
The strategy builder creates target revenue forecasts from knowledge of:
Market size and current sales of similar products and services in this market. The proposed strategy will either focus on a narrow market or a broad market.
The firms likely market share and competitors market share.
The firms ability to differentiate itself from the competition under the possible strategy. Also, the firms ability to benefit from strong branding under the strategic plan. The firm will differentiate either by unique product attributes, branding or through low-cost pricing.
Forecasting Target Expenses for the Model
The strategy builder forecasts expense forecasts from knowledge of:
Target revenues and the firms current Cost of goods sold or Cost of services.
Cost structure changes under the proposed strategy.
Alphas Strategy: Broad Differentiation
Firm alpha has chosen to propose a broad differentiation strategy. The firm intends to differentiate itself primarily in these terms:
emphasizing product quality, cutting-edge design, and desirability. Branding efforts will communicate product qualities central to the firms value proposition.
Unique product features and capabilities
. For these, Alpha intends to achieve market penetration and market leadership by being first to market.
Alphas model in Exhibit 2 shows the likely results of applying this strategy: Gross margins for products and services are relatively high (37% and 30%, respectively). However, Alphas expenses for selling, administration, and overhead are also relatively high. Therefore, despite the high gross margins, the overall after-tax net (operating) profit margin is only 5.0%
Firm beta has chosen to propose a cost leadership strategy, targeting a broad market. For this, Beta will differentiate itself from competitors by selling at prices below industry averages. Success with the strategic plan depends on keeping expenses low.
Applying this strategy, Beta forecasts lower gross margins than Alpha for products and services (21% and 10%, respectively). Nevertheless, Betas lower cost structure still results in an overall after-tax net operating profit margin of 5.0%
Should either firm choose its proposal strategy? The answer depends on these considerations.
The forecast margins are credible as long as the revenue and expense estimates are plausible. To enhance believability, the model builders will probably provide:
Conservative revenue estimatesrealistic, but lower than the firms most likely revenue estimates.
Pessimistic expense estimatesrealistic, but somewhat higher than the firms most likely cost estimates.
of the forecast profits and net profit margin.
Alpha, for instance, forecast net profits of $7,505,000 and a net profit margin of 5%. Because the general strategy objective is to increase owner value by earning, sustaining, and growing profits, Alpha will have to decide whether these results are Excellent, Just acceptable, or Unacceptable. Here, Alpha will judgeacceptabilityby using model results to address other questions:
Are these profits and margins sustainable? Do they point to