What is Strategic Management?

A formal definition tells us that strategic management “is the process by which a firm manages the formulation and implementation of its strategy” (Carpenter & Sanders, 2009, p. 8). Strategic management, strategy in short, is about choice—in terms of what the organization will do and won’t do to achieve specific goals and objectives.

The choices an organization makes about strategy are in the service of creating a competitive advantage. For the most part, this chapter emphasizes strategy formulation as opposed to strategy implementation (“What should our strategy be?” versus “How do we implement our strategy?”). It also does not attempt to define competitive analysis (answers to “Who are we?” and “Who is our competition?”). The central concept of strategy in Figure 1.1 is that it is a cycle not a straight line.

We generally begin using the AFI Strategy Framework with analysis or evaluating the results of previous actions and understanding their impact. Taken together, the analysis and formulate activities are generally what is referred to in strategic management as strategic planning. Planning reflects what a firm is doing, or thinks it is doing, to achieve its mission and vision through specific goals and objectives. But planning alone is not strategic management; action (referred to as implementation or execution) is also required.

Expanding on the earlier definition of strategic management above, the strategic management process (SMP) is a “coordinated means by which an organization achieves its goals and objectives” in service of its mission and vision (Carpenter & Sanders, 2009, p. 10). Others have described strategy as the pattern of resource allocation choices and organizational arrangements that result from managerial decision making. (Mintzberg, 1978). Strategy implementation then refers to the tasks and tactics managers must perform to put the desired strategy into action.

The process can be broken into four steps including: (1) Understand the environment in which the company is operating to, (2) plan the best course of action given its unique strengths, weaknesses, and capabilities. Next, the firm must (3) execute the strategic plan and regularly and systematically conduct a study to, (4) evaluate the plan to ensure the firm’s long-term success. The SMP is relevant to all types of organizations from large, publicly traded companies to religious organizations, political parties, and nonprofits.

Trade-offs

Three of the most widely read books on competitive analysis in the 1980s were Michael Porter’s Competitive Strategy, Competitive Advantage, and Competitive Advantage of Nations. In his books, Porter developed three generic business strategies that, he argues, can be used singly or in combination to create a defendable position and to outperform competitors, whether they are within an industry or across nations. The strategies are (1) overall cost leadership, (2) differentiation, and (3) focus on a particular market niche (Magretta, 2011). We’ll discuss these strategies further in Chapter 5: Business-level Strategy.

According to Porter, as firms consider their strategy, they face trade-offs. These happen for a number of reasons including

1. The incompatibility of product features – a product that meets the needs of one set of requirements well and is poor at meeting others;
2. The activities themselves – a chain of tasks to best deliver one kind of value creates conflict with other values; and
3. Inconsistencies of image or reputation – imagine a staid insurance provider introducing equipment for skydiving where the risk of the sport is inconsistent with the image of a safe financial instrument.

At the same time, Porter warns of false trade-offs. His assertion is that trade-offs are only real when firms have competitive parity in the execution of their strategy. That is, their product has the same valuable characteristics (quality, features, service, and attributes) as their competition. Only then will a focus on one part of the organization or product result in harm to another. Until that happens a firm may hide its lack of operational excellence as a trade-off. For example, a firm might consider high quality and low cost a trade-off. But Lexus was able to offer just that in the 1990s in competition with General Motor’s Cadillac Division because their manufacturing processes were so much more advanced; you could get a loaded 1999 Lexus GS for less money and more features than a comparable 1999 Cadillac Seville. Plus, more than 20 years later that same Lexus sells for 30% more than its rival (Cars.com, n.d.).

Real trade-offs keep competitors in check. If a firm is successful in its strategy and its competitors are aware of its competitive actions, the competitors will try to copy. Without real trade-offs, any good concept in delivering customer value can be duplicated. When the trade-offs are real, however, competitors must pay an economic penalty to follow (Magretta, 2011).

Sustainable Competitive Advantage (SCA)

As mentioned earlier, the goal of all firms is to create a competitive advantage. But what gives one organization an advantage over another? We’ll address this in greater detail in Chapter 4: Internal Resources, but it’s important for us to have a basic understanding of this goal before going further.

First, let’s define what we mean by competitive advantage. Quite literally, competitive advantage is anything that one organization has or does better than any of its rivals—this is known as the customer value proposition. A coffee shop that makes better coffee than its rivals in town has a competitive advantage in the eyes of a specific portion of the market of coffee drinkers. Obviously, other customers likely care more about the price of coffee or perhaps whether it is ethically sourced than the taste of the product—after all, taste can be fickle. If enough coffee drinkers agree that our coffee shop’s product tastes better than everyone else’s, we have a competitive advantage. But if our shop’s advantage is a two-for-one special, then our competitive advantage will be very short-lived as promotions like this are easily copied.

This brings us to the concept of sustainable competitive advantage (SCA). For our coffee shop to make sure their advantage is not transient, they must have or do something that cannot be easily copied in terms of time or money. If they have a patented brewing process (unlikely), they’ll be able to sustain their taste advantage for quite some time—at least until the patent expires. However, if their coffee-drinking environment provides a unique experience delivered by happy and friendly baristas and an inviting atmosphere, this experience will be harder to copy. Hiring the right people could be expensive and creating an inviting atmosphere will take time, but these trade-offs make the competitive advantage sustainable over a longer period of time.

Apple Inc. has achieved an SCA through a combination of product differentiation, brand loyalty, ecosystem integration, and innovation. The company has consistently delivered high-quality products, infused strong customer service to guide seamless user experiences, and created a vast ecosystem entailing complementary services to support its products and user experiences. All of these advantages are hard to duplicate at the scale Apple is currently able to provide, and competitors cannot replicate them, giving Apple a favorable long-term position over its competitors. Overall, Apple has established a strong market position and SCA in the technology industry (Marino-Nachison, 2023).

Above Average Returns (AAR)

But what’s the point of all this effort to achieve a SCA? Simply, firms pursue SCAs to generate above average returns (AAR). To understand this drive for AAR we look to finance for an explanation. The field of finance describes a return as the result of an investment. And an average return is the result that most organizations can expect from providing a particular product or service in a competitive market scenario. Think of it as the best of the worst and the worst of the best.

An AAR then refers to profit from the revenue of a firm that is above the average for all competitors within that particular industry. Investors seek returns equal to or above what they can earn from other investments with a similar amount of risk and return. Investors reward firms that provide AAR with stronger stock values and a greater willingness to loan capital. Likewise, a firm generating AAR can survive longer when the market turns down because their finances are less vulnerable to market pressures.

External Versus Internal Models of AAR

Two differing views of AAR account for most of the factors that lead to the profit of any given firm in any given industry. From the 1960s, the Industrial Organizational (I/O) Model for AAR held favor. It starts with the assumption that forces external to the company represent the dominant influences on a company’s strategic actions (Hoskisson et al., 1999). This model assumes the characteristics of and conditions present in the external environment determine the effectiveness of a strategy for a company to earn AAR. The I/O model specifies that the choice of industries in which to compete has more influence on company performance than the decisions made by the managers inside the firm. Research shows that 20% of profitability can be directly attributed to the I/O model (McGahan & Porter, 2003).

This same research, however, discovered that 36% of the variance in firm profitability can be attributed to a firm’s unique characteristics and actions. This Resource-based Model for AAR states that internal uniqueness is most important in determining strategy. This model presumes that the characteristics of and conditions present in the internal environment dictate the strategies a company will employ to earn AAR. The resource-based model specifies that the way a firm manages its resources (people and assets) has more influence on the company’s overall performance than pressure from outside forces.

Taken together, these two models help a firm determine in which industries they should compete (I/O model) and what actions are most likely to generate success (resource-based model) (Kapoor & Furr, 2015). Still, these two models only account for a little more than chance. Suggesting, as a colleague expressed to one of the authors (John), “It’s better to be lucky than good. But luck favors the prepared” (E. Ahlvin, personal communication, 2008).

Risk

In business as in all ventures—for profit, nonprofit, non-governmental organization, government, military—you can’t speak about SCA and AARs without also considering risk. Risk broadly refers to the probability of failure, loss, and danger associated with any competitive action. Risks are acceptable in business when a return, preferably an AAR, will result. But risk has multiple dimensions—such as the probability and the severity of loss—you must also consider. For example, if I lay a 10-ft-long 4-by-4 beam on the floor and offer you $1 to walk across it, the reward ($1), probability of failure (stepping off the 4-in. beam), and the severity of loss (stepping down 4 in.) are all low. However, if I move this same beam 100 ft in the air between two buildings, the risk of failure is the same, but the severity of failure has increased dramatically; such a move will certainly require a much higher reward. For most of us, at 100 ft in the air, no reward is worth the risk!

In the same way, businesses that undertake new strategic initiatives are certain to consider the opportunity for return considering the probability and severity of loss if failure occurs. For most organizations, when the severity of loss is total failure of the enterprise, no reward will outweigh the risk, no matter how small the probability and how great the reward. Fortunately, most strategies don’t come with such extreme risk as total failure of the organization. Still, when undertaking new initiatives, most organizations will also undertake activities to hedge or mitigate (reduce) the risks associated with their competitive actions.

Risk in business generally derives from a combination of uncertainty and complexity. Uncertainty exists because even the simplest decisions don’t have a 100% guarantee of success. Likewise, companies are faced with growing complexity with respect to environmental, political, and competitive changes. In response to such pressures, companies often reflect external complexity within their organizational structures. For example, a firm might address increasing cost pressures and accelerating innovation in their market by building a more complex matrix organization or adding new processes to address the evolving needs. In isolation, each of these responses makes sense, but in combination, they have the potential to create significant problems. Complexity leads to uncertainty and vice versa, and the combination can create a self-reinforcing downward cycle impacting organizational performance and executive decision making.

AFI Strategy Framework

Introduced earlier in this chapter, Figure 1.5 takes the AFI Strategy Framework—or analyze, formulate, and implement—further by reflecting the dynamic nature of how business works in the real world. A firm’s business model and their ability to convert resources into AAR, typically shapes their strategic plans. But conditions change, opportunities go away, new rivals emerge, and competitive strategies are realized. We’ll address these concepts as we explore the AFI Strategy Framework more deeply.

Theory: The Making of Strategy

To make strategy at the most basic level, you need to gather information and conduct analysis about both the internal characteristics of the organization and the external market conditions. Internally, we want to understand the organization’s strengths and weaknesses; on the external side, we want to know the organization’s opportunities and threats. Together, these four factors (strengths, weaknesses, opportunities, and threats) are referred to as SWOT analysis; we’ll cover this type of analysis in Chapter 4: Internal Resources.

It doesn’t matter if you start your appraisal internally or externally, but it quickly becomes obvious that the two perspectives need to mesh eventually. For example, a firm’s business model dictates how it delivers its customer value proposition, which in turn pays for the goods and services it offers in the market. The perceived value of its product allows the firm to convert payments for resources into a profit. Along the way to creating a competitive advantage and achieving AAR, firms often find that conditions have changed and an initiative that was advantageous is no longer practical or useful. Such a thought-out plan that is no longer used because it is not profitable or not effective for the company is said to be an abandoned strategy.

The primary determinant of realized strategy is what Henry Mintzberg calls emergent strategy—the decisions that emerge from the complex processes in which individual managers interpret the intended strategy and adapt to changing external circumstances (Mintzberg, 1978; Mintzberg, 1988; Mintzberg & Waters, 1985). Thus, the realized strategy is a consequence of deliberate, abandoned, and emerging factors (Figure 1.6).

Robert Grant, author of Contemporary Strategy Analysis, describes strategy making as combining design and emergence. The deliberate design of strategy (through formal processes such as board meetings and strategic planning) has been characterized as primarily a top-down process. Emergence has been viewed as the result of multiple decisions at many levels, particularly within middle management, and has been viewed as a bottom-up process. These processes interact in interesting ways (Burgelman & Grove, 1996; Grant, 2002).

In practice, both design and emergence occur at all levels of the organization. The strategic planning systems of large companies involve top management passing directives and guidelines down the organization and the businesses passing their draft plans up to headquarters. Similarly, emergence occurs throughout the organization—opportunism by CEOs is probably the single most important reason why realized strategies deviate from intended strategies. What we can say for sure is that the role of emergence relative to design increases as the business environment becomes more volatile and unpredictable.

Organizations that inhabit relatively stable environments—the Roman Catholic Church and national postal services—can plan their strategies in some detail. Organizations whose environments cannot be forecasted with any degree of certainty—an international drug cartel or a construction company located in a depressed area—can establish only a few strategic principles and guidelines; the rest must emerge as circumstances unfold.

Mintzberg’s advocacy of strategy making as an iterative process involving experimentation and feedback is not necessarily an argument against Grant’s rational, systematic design of strategy. The critical issues are, first, determining the balance of design and emergence and, second, how to guide the process of emergence. The strategic planning systems of most companies involve a combination of design and emergence. Thus, headquarters sets guidelines in the form of vision and mission statements, business principles, performance targets, and capital expenditure budgets. However, within strategic plans, divisional and business unit managers typically have considerable freedom to adjust, adapt, and experiment.

ESPN’s original goal was to create a cable television network that solely focused on sports events in the state of Connecticut. It was created by father and son, Scott and Bill Rasmussen, and a close friend Ed Eagan. Bill was fired from the New England Whalers, a professional ice hockey team who are now known as the Carolina Hurricanes and decided to move on by continuing his love for sports through local broadcasting. This intended strategy shifted into an emergent strategy when the network became successful and formed “ESPN,” branching out beyond local sporting events. The realized strategy evolved, and ESPN is now known as the worldwide leader of sports, owning multiple ESPN affiliates as well as ESPN magazine, radio, and broadcasting for ABC network. ESPN’s goal now is “To Serve Sports Fans,” rather than simply serve the people of Connecticut (ESPN.com, 2014).

Toolkit: The Strategy Diamond

All organizations have strategies (whether acknowledged or not). The real question for a business is not whether it has a strategy, but rather whether its strategy is effective or ineffective and whether the elements of the strategy are chosen by managers, luck, or default. You have probably heard the saying, “Luck is a matter of being in the right place at the right time.” The key to making sure you are in the right place at the right time is preparation, and in many ways, strategizing provides that type of preparation. Luck is not a bad thing. The challenge is to recognize luck when you see it, capitalize on luck, and put the organization repeatedly in luck’s path.

The Strategy Diamond (Figure 1.7) was developed by strategy researchers Don Hambrick and Jim Fredrickson (2001) as a framework for checking and communicating a strategy. In critiquing the field of strategy, these researchers noted that “after more than 30 years of hard thinking about strategy, consultants and scholars have provided executives with an abundance of frameworks for analyzing strategic situations. Missing, however, has been any guidance as to what the product of these tools should be—or what actually constitutes a strategy” (Hambrick & Frederickson, 2001). Chapter 5: Business-level Strategy will discuss the need for focus and choice.

Because of their critique and analysis, they concluded that if an organization must have a strategy, then the strategy must necessarily have parts. The diamond model does not presuppose that any particular theory should dictate the contents of each facet. Instead, a strategy consists of an integrated set of choices, but it isn’t a catchall for every important choice a manager faces.

We refer to the first three facets of the Strategy Diamond—arenas, differentiators, and economic logic—as traditional in the sense that they address three longstanding hallmarks of strategizing. Specifically, strategy matches up market needs and opportunities (located in arenas) with unique features of the firm (shown by its differentiators) to yield positive performance (economic logic). While performance is typically viewed in financial terms, it can have social or environmental components as well.

Arenas

Strategy questions about arenas identify where the firm will be active and with how much emphasis.

• Which product categories?
• Which channels?
• Which market segments?
• Which geographic areas?
• Which core technologies?
• Which value-creation strategies?

Beyond geographic-market and product-market arenas, an organization can also make choices about the value-chain arenas in its strategy. To emphasize the choice part of this value-chain arena, Nike’s competitor New Balance manufactures nearly all the athletic shoes that it sells in the United States. Thus, these two sports-shoe companies compete in similar geographic- and product-market arenas but differ greatly in terms of their choice of value-chain arenas.

Prior to October 2019, NBA teams were not legally allowed to sign up for two advertising sponsors outside of the United States and Canada. Teams were restricted to national geographical markets or areas outside of their home games. For instance, the NBA didn’t permit Celtics players (based in Boston) to go to Hollywood, California (the Laker’s market), to promote their brand. This development goes beyond the domestic market and further expands the NBA’s arena into the global market, thereby creating new international opportunities. Now, players are able to sign two advertising sponsors outside the United States and Canada (Patel, 2019).

Differentiators

These are the things that are unique to the firm such that they give it a competitive advantage in its current and future arenas. Differentiators are concerned with the question, how will the firm win?

• Image?
• Customization?
• Price?
• Styling?
• Product reliability?
• Speed to market?

A differentiator could be asset based, related to an organization’s tangible or intangible assets. A tangible asset is something with value that physically exists. Land, machines, equipment, automobiles, and even currencies, are tangible assets. The oceanfront land on California’s Monterey Peninsula, where the Pebble Beach Golf Course and Resort is located, is a differentiator in the premium golf-course market. An intangible asset is a nonphysical resource that provides gainful advantages in the marketplace. Brands, copyrights, software, logos, patents, goodwill, and other intangible factors afford name recognition for products and services. Differentiators can also be found in capabilities, that is, how the organization does something. Walmart, for instance, is very good at keeping its costs low due to its unique capabilities.

Emirates Airlines has tuned in on utilizing a differentiation strategy to make it unique and more appealing than its airline competitors. Emirates has focused on creating a more “premium” experience by positioning itself as a luxury airline, providing comfort and personalized attention throughout the travel experience. Its luxurious amenities include spacious seating, gourmet meals, and a wide array of entertainment options. These are all aspects that other airlines do not capitalize on, providing Emirates with a competitive differentiation advantage. Airlines such as Alaska, have favorable attributes, but are not labeled as “luxury,” and this luxury attribute favorably positions Emirates in the minds of its consumers (Cui & Li, 2022).

Economic Logic

This explains how the firm makes money above its cost of capital.

• Lowest costs through scale advantages?
• Lowest costs through scope and replication advantages?
• Premium prices due to unmatchable service?
• Premium prices due to proprietary product features?

While economic logic can include environmental and social profits (benefits reaped by society), a strategy must earn enough financial profits to keep stakeholders (owners, taxpayers, communities, and governments) willing to continue to fund the organization’s costs of doing business. A firm performs well (i.e., has a strong, positive economic logic) when its differentiators are well aligned with its chosen arenas.

After Russia’s refusal to reduce output, Saudi Arabia significantly reduced its official crude oil selling prices and synchronously reported an increase in production. This immediate change in strategy had an influential impact on the market, which was already severely affected by the COVID-19 pandemic. The International Energy Agency (IEA) reported that approximately 5% of global oil production was then facing financial loss due to low market prices (Smith, 2020).

Vehicles

You can see why the first three facets of the Strategy Diamond—arenas, differentiators, and economic logic—might be considered the traditional facets of strategizing in that they cover the basics: (1) external environment, (2) internal organizational characteristics, and (3) some fit between them that has positive performance consequences. If arenas and differentiators show where you want to go, then vehicles communicate how the strategy will get you there.

• Internal development?
• Joint ventures?
• Licensing/franchising?
• Alliances?
• Acquisitions?

Specifically, vehicles refer to how you might pursue a new arena through internal means, through help from a new partner or some other outside source, or even through acquisition. In the context of vehicles, this is where you determine whether your organization is going to grow organically, through acquisition, or a combination of both. Organic growth is the growth rate of a company excluding any growth from takeovers, acquisitions, or mergers. Acquisitive growth, in contrast, refers precisely to any growth from takeovers, acquisitions, or mergers.

Vehicles are considered part of the strategy because there are different skills and competencies associated with different vehicles. For instance, acquisitions fuel rapid growth, but are challenging to negotiate and put into place. Similarly, alliances are a great way to spread the risk and let partners focus on what they do best. At the same time, growing through alliances also means being good at managing relationships in which the firm is dependent on another organization over which it does not have direct control. Organic growth, developing capabilities internally, has its own distinct challenges in that the organization is on its own to put together everything it needs to fuel its growth.

Microsoft’s acquisition of Nuance Communications, a leading provider of conversational artificial intelligence (AI) and health care-focused solutions, marks a significant move for the technology giant. With this strategic acquisition, Microsoft aims to bolster its position in the health care sector and advance its capabilities in the field of AI. By acquiring Nuance’s advanced AI technologies, including voice recognition and natural language processing, Microsoft aims to enhance its health care-focused offerings. Integration of these technologies into existing products like Microsoft Teams and Azure cloud platform can improve communication and collaboration in health care settings. Nuance’s expertise in health care, combined with Microsoft’s resources, enables innovation in health care technology, telemedicine, electronic health records, and personalized health care solutions. This acquisition expands Microsoft’s presence in health care and paves the way for transformative health care solutions (Chapman, 2022).

Stages and Pacing

Staging and pacing constitute the fifth and final facet of the Strategy Diamond and describes what will be a firm’s speed and sequence of moves. This powerful facet of the Strategy Diamond helps us think about timing and next steps instead of thinking of strategy as a static, monolithic plan. Strategizing is about making choices, and sequencing and speed are key choices along with the other facets of a strategy. The staging and pacing facet also help to reconcile the designed and emergent portions of a strategy.

As a result of the COVID-19 pandemic and the imposed restrictions on outdoor activities, physical stores faced closures. However, there was a remarkable surge in online sales of ramen on Walmart Inc.’s website, experiencing an increase of nearly 600%. Similarly, other shelf-stable essentials were seeing significant rises in demand through online platforms. Recognizing the potential of this crisis, Walmart is addressing the needs of individuals facing restricted living situations. Meanwhile, people confined to their homes are actively accumulating easily stored food and medical/health supplies in preparation for prolonged indoor stays (Boyle, 2020).

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