chap - 6 strategic options

The Institute of Chartered Accountants in England and Wales, March 2009 203

Contents

chapter 6

Strategic options

Introduction

Examination context

Topic List1 Rational planning model revisited

2 Corporate appraisal (SWOT analysis)

3 Gap analysis

4 Generic competitive strategies: how tocompete

5 Product-market strategy: direction of growth

6 Other strategies

Summary and Self-test

Answers to Self-test

Answers to Interactive questions

Business strategy

204 The Institute of Chartered Accountants in England and Wales, March 2009

Introduction

Learning objectives Tick off

Identify and describe, in a given scenario, the alternative strategies available to a business

Explain, using information provided, how to position particular products and services in amarket to maximise competitive advantage

Specific syllabus references for this chapter are: 1c, 2b.

Practical significanceManagement cannot expect to deliver commercial success by carrying on doing the same things year afteryear. The business environment changes, competitive pressures intensify and customers' needs change.

Strategic options, even simply cost-cutting, must be generated and decisions taken.

Stop and thinkConsider two firms with which you are familiar. One can be the one you work for.

What have they done in the past that has made a difference to their competitive position today?

What are they intending to do in the future?

What things did they consider doing and then not carry on with?

Those are the strategic options.

Working contextClient's future prospects will depend on the strategic options they develop. The risks they run will also beinfluenced by these.

Syllabus linksThe basic concepts of competitive strategy and strategic growth were covered in your Business and Financepaper. Here they are considered further and applied to scenario problems of the sort you may face in yourexamination.

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Examination context

Exam requirementsThis chapter looks at various models which can assist an organisation in developing its products andmarkets and in choosing strategies for competitive advantage. In the exam these models can be used toassess the strategies already identified in the question or as a way of generating strategic options for thebusiness. Either way, the concepts of SWOT analysis, Porter's generic strategy model and Ansoff's growthmatrix are fundamental knowledge for the Business Strategy exam.

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1 Rational planning model revisited

Section overview The development of strategic options involves the final three steps of the rational model

Choices involve understanding the present situation, identifying gaps, and developing potential ways todeal with this.

1.1 The rational modelChapter 1 introduced the rational model.

EXTERNALANALYSIS

INTERNALANALYSIS

CORPORATEAPPRAISAL

MISSION ANDOBJECTIVES

GAP

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

REVIEW ANDCONTROL

STRATEGICANALYSIS

STRATEGICCHOICE

STRATEGYIMPLEMENTATION

The present chapter considers three of the stages:

Corporate appraisal: Combining assessment of environment (Chapters 3 and 4) with assessment ofresources, competences and capabilities (Chapter 5) to help management identify the strategicposition of the business and its forecast performance.

Gap analysis: Management compare forecast performance with the strategic objectives of thebusiness to identify where strategic adjustments are needed to deliver planned performance.

Strategic option development: Management generate and evaluate strategic options to close theplanning gap identified.

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1.2 Three strategic choices: overviewJohnson, Scholes and Whittington (Exploring Corporate Strategy) identify three distinct groups of strategicoptions. Strategic choice requires that management makes choices under each of the following:

Competitive strategy: The way that the firm will seek to win customers and secure profitabilityagainst rivals. This is covered in the present chapter and continued in Chapter 7 where marketingstrategy is discussed.

Product/market strategy: The decision on what products to offer over the coming years and themarkets to be served This is covered in section 5 of this chapter and again continued in Chapter 7.

Development strategy: The decision on how to gain access to the chosen products and markets.Discussion of this choice is reserved until Chapter 10.

Worked example: Virgin groupThe following extracts from the Virgin Website (2007) illustrate the way this international consumer goodsand services corporation applies the 'three strategic choices' approach.

'Competitive strategy

Virgin one of the most respected brands in Britain is now becoming the first global brand name of the21st century. We are involved in planes, trains, finance, soft drinks, music, mobile phones, holidays, wines,publishing, space tourism, cosmetics the lot! What ties all these businesses together are the values of ourbrand and the attitude of our people.

We have created over 200 companies worldwide, employing over 35,000 people. Our annual total revenuesaround the world exceed 4 billion (US$7.2 billion).

All the markets in which Virgin operates tend to have features in common: they are typically markets wherethe customer has been ripped off or under-served, where there is confusion and/or where the competitionis complacent.

In these markets, Virgin is able to break into the market and shake it up. Our role is to be the consumerchampion, and we do this by delivering to our brand values, which are:

Value for money

Simple, honest and transparent pricing not necessarily the cheapest on the market.

e.g. Virgin Blue Australia low cost airlines with transparent pricing.

Good quality

High standards, attention to detail, being honest and delivering on promises.

e.g. Virgin Atlantic Upper Class Suite limousine service, lounge, large flat bed on board, freedom menuetc.

Innovation

Challenging convention with big and little product/service ideas; innovative, modern and stylish design.

e.g. Virgin Trains new Pendolino fast tilting train with shop, radio, digital seat reservations and new sleekdesign.

Brilliant customer service

Friendly, human and relaxed; professional but uncorporate.

e.g. Virgin Mobile UK which has won awards for its customer service, treats its customers as individuals,and pays out staff bonuses according to customer satisfaction survey results.

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Competitively challenging

Sticking two fingers up to the establishment and fighting the big boys usually with a bit of humour.

e.g. Virgin Atlantic successfully captured the public spirit by taking on BA's dirty tricks openly and winning.Later, advertising messages such as BA Don't Give A Shiatsu both mocked BA and delivered a positivemessage about the airline's service.

Fun

Every company in the world takes itself seriously so we think it's important that we provide the public andour customers with a bit of entertainment.

e.g. VAA [Virgin Atlantic Airways] erected a sign over the BA-sponsored, late finishing London Eye saying:BA Can't Get It Up. Virgin Cola's launch in USA saw Richard [Branson: entrepreneurial founder andchairman of Virgin] drive a tank down 5th Avenue and then 'blow up' the Coke sign in Times Square,mocking the 'cola wars'.

Product/market strategy

Travel and tourism Leisure and pleasure Social and environment

e.g. e.g. e.g.

Virgin Atlantic V Festival Virgin Fuels

Virgin Balloon Flights V2 Music Virgin Unite

Virgin Holidays Virgin Experience Days Virgin Earth

Virgin Trains Virgin Spa

Shopping Media andtelecommunicationsFinance and money

e.g. e.g. Virgin Money

Virgin Books Virgin Mobile

Virgin Digital Virgin Media

Virgin Drinks Virgin Radio

Virgin Megastore

Development strategy

We draw on talented people from throughout the group. New ventures are often steered by peopleseconded from other parts of Virgin, who bring with them the trademark management style, skills andexperience. We frequently create partnerships with others to combine skills, knowledge, market presenceand so on.

Once a Virgin company is up and running, several factors contribute to making it a success. The power ofthe Virgin name; Richard Branson's personal reputation; our unrivalled network of friends, contacts andpartners; the Virgin management style; the way talent is empowered to flourish within the group. To sometraditionalists, these may not seem hard headed enough. To them, the fact that Virgin has minimalmanagement layers, no bureaucracy, a tiny board and no massive global HQ is an anathema.

Our companies are part of a family rather than a hierarchy. They are empowered to run their own affairs,yet other companies help one another, and solutions to problems come from all kinds of sources. In a sensewe are a community, with shared ideas, values, interests and goals. The proof of our success is real andtangible.

Exploring the activities of our companies through this web site demonstrates that success, and that it is notabout having a strong business promise, it is about keeping it!

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Although the Virgin group is a family of businesses with a shared brand, all of the companies runindependently. Often the companies are set up as joint ventures with other partners, so they all havedifferent shareholders and boards.'

2 Corporate appraisal (SWOT analysis)

Section overview Before dreaming up options management needs to take stock of the present position of the business.

A SWOT analysis is an important technique for visualising the situation and is drawn from theenvironmental assessment and internal appraisal already conducted.

2.1 Role of corporate appraisalA complete awareness of the organisation's environment and its internal capacities is necessary for arational consideration of future strategy, but it is not sufficient. The threads must be drawn together sothat potential strategies may be developed and assessed. The most common way of doing this is to analysethe factors into strengths, weaknesses, opportunities and threats. Strengths and weaknesses arediagnosed by the internal analysis, opportunities and threats by the environmental analysis.

Here are some examples of questions that might be asked to assess an organisation's opportunities andthreats.

Opportunities

What opportunities exist in the business environment? What is their inherent profit-making potential? What is the organisation's ability to exploit the worthwhile opportunities?

Threats

What threats might arise? How will competitors be affected? How will the company be affected?

The opportunities and threats might arise from the PEST and competitive factors.

2.2 Bringing them together the cruciform chartEffective SWOT analysis does not simply require a categorisation of information, it also requires someevaluation of the relative importance of the various factors under consideration.

A cruciform chart (literally 'cross form') can be drafted on a flip-chart by the person facilitating the strategydiscussions. Its benefits are:

Limitations on space restricts management to focusing on the big points

Allows mapping of connections between points (see below)

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Match strengths with market opportunities

Strengths which do not match any available opportunity are of limited use while opportunities whichdo not have any matching strengths are of little immediate value.

Conversion

This requires the development of strategies which will convert weaknesses into strengths in order totake advantage of some particular opportunity, or converting threats into opportunities which canthen be matched by existing strengths.

Interactive question 1: Hall Faull Downes Ltd [Difficulty level: Intermediate]Hall Faull Downes Ltd has been in business for 25 years, during which time profits have risen by an averageof 3% per annum, although there have been peaks and troughs in profitability due to the ups and downs oftrade in the customers' industry. The increase in profits until five years ago was the result of increasing salesin a buoyant market, but more recently, the total market has become somewhat smaller and Hall FaullDownes has only increased sales and profits as a result of improving its market share.

The company produces components for manufacturers in the engineering industry.

In recent years, the company has developed many new products and currently has 40 items in its rangecompared to 24 only five years ago. Over the same five year period, the number of customers has fallenfrom 20 to nine, two of whom together account for 60% of the company's sales.

Give your appraisal of the company's future, and use a SWOT analysis to suggest what it is probably doingwrong.

See Answer at the end of this chapter.

2.3 Weirich's TOWS matrixWeirich, one of the earliest writers on corporate appraisal, originally spoke in terms of a TOWS matrix inorder to emphasise the importance of threats and opportunities. It has several benefits:

It provides a clear set of steps to move from SWOT to the formulation of strategic options.

It makes management aware of the need for defensive strategies (WT) in addition to strategies tograsp opportunities.

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Strengths Weaknesses

Note that this is therefore an inherently positioning approach to strategy. A further important element ofWeirich's discussion was his categorisation of strategic options:

SO strategies employ strengths to seize opportunities. ST strategies employ strengths to counter or avoid threats. WO strategies address weaknesses so as to be able to exploit opportunities. WT strategies are defensive, aiming to avoid threats and the impact of weaknesses.

One useful impact of this analysis is that the four groups of strategies tend to relate well to different timehorizons. SO strategies may be expected to produce good short-term results, while WO strategies are likelyto take much longer to show results. ST and WT strategies are more probably relevant to the medium term.

Interactive question 2: Fleetrail [Difficulty level: Exam standard]Fleetrail Ltd is a wholly-owned subsidiary of Twenty-first Century Transport Ltd ('TCT'). TCT is a majorStock Exchange listed holding company whose other subsidiaries are involved in passenger transport,notably scheduled express coach services linking various UK cities, and scheduled airlines operating bothwithin the UK and between certain UK cities and destinations in several European Union countries.

Fleetrail Ltd was created to bid for the franchise to operate passenger trains on the main line betweenLondon and Norington, a major UK provincial city ('the route'). The bid was successful and the franchisebecame effective from 1 April 1997 to last for seven years. The route represents the only practical rail linkbetween London and Norington and intermediate stations along the route.

Under the terms of the franchise contract the UK government paid Fleetrail Ltd a subsidy of CU200 millionfor the year ended 31 March 1998. Subsidies in subsequent years will reduce in annual equally-sized steps,such that by the year ending 31 March 2004 Fleetrail Ltd will receive a subsidy of only CU35 million. Thefranchise contract specifies that Fleetrail Ltd is not allowed to reduce services or increase prices in realterms, relative to the pre-1 April 1997 levels, without incurring significant financial penalties.

Fleetrail Ltd has to pay Railtrack Ltd, the company which owns the railway lines and stations on the route, arental based on the usage of those lines. This rental is a matter of periodic negotiation between Fleetrail Ltdand Railtrack Ltd, but the government-appointed regulator will intervene and set the price whereagreement is not reached.

Under the terms of the franchise the rolling stock (carriages and locomotives) used on the route are to beleased from one of the three competing leasing companies. The leasing companies lease rolling stock out totrain operators, including Fleetrail Ltd. These companies will also acquire new rolling stock in due course,according to the needs of their customers.

In the year ended 31 March 1997, the last year under British Rail management, ticket sales totalled CU90million and the route attracted a subsidy of CU250 million. During Fleetrail Ltd's first year operating costswere roughly met by the total of ticket sales and the CU200 million subsidy. The route currently employs4,000 staff, nearly all of whom were 'inherited' by Fleetrail Ltd.

SO Strategies WO Strategies

WT StrategiesST Strategies

Opportunities

Threats

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Requirements

(a) As far as the information given in the question will allow, undertake an analysis of the strengths,weaknesses, opportunities and threats (SWOT analysis) of Fleetrail Ltd. Each point raised must beexplained and justified as to why it is seen as a strength, weakness, opportunity or threat. You shouldprovide some indication of the importance of each point which you make.

(b) Indicate what additional information you would need to obtain, and why you need it, to enable you tocomplete your SWOT analysis of Fleetrail Ltd.

(c) Having carried out the SWOT analysis, how would the management of Fleetrail Ltd use it to proceedto the formulation of a suitable strategy? (You are not required to identify a suitable strategy for thecompany.)


3 Gap analysis

Section overview Gap analysis helps management visualise the ground to be made up between their intentions for the

performance of the business and its forecast performance without new initiatives (strategies).

There are three groups of strategies to help close the shortfall of performance (gap): improveefficiency, develop new market and products, and diversify.

3.1 Overview of gap analysisGap analysis compares two things:

The organisation's targets for achievement over the planning period

What the organisation would be expected to achieve if it carried on in the current way with thesame products and selling to the same markets, with no major changes to operations. This is called anF0 forecast, by Argenti.

DefinitionGap analysis: The comparison between an entity's ultimate objective and the expected performance fromprojects both planned and under way, identifying means by which any identified difference, or gap, might be filled.

Currentposition

Strategicobjective Strategic objective (F )1

Time

Forecast ( )F0

Planning gap

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3.2 Strategies to fill the gapThe planning gap may originate from a number of causes:

Ambitious objectives being set by management (or imposed on management by investors) Underperformance of existing product portfolio (e.g. maturity stage approaching) Difficult environment (e.g. industry or economic slow-down)

The gap could be filled by new product-market growth strategies. For example a management team wishingto increase profitability might consider:

Efficiency strategies: reduce the costs of present products and economise on the assets used. Expansion strategies: develop new products and/or new markets. Diversification strategies: enter new industries which have better profit and growth prospects.

These are illustrated below.

Gaps can also be closed by the simple expedient of setting the objectives lower. Most writers on strategyregard this remedy as an unacceptable admission of defeat by management.

4 Generic competitive strategies: how to compete

Section overview Firms must position themselves well in two markets: the market for their products; and in the stock

market.

Porter's concept of competitive advantage states that such positioning can be achieved only in threemutually exclusive ways: cost leadership, differentiation and focus.

4.1 Competitive advantageCompetitive advantage is anything which gives one organisation an edge over its rivals.

In the 1960s and 1970s this tended to be interpreted solely in terms of the marketing concept of providingthe customer with superior benefits and so winning sales.

Porter widened the concept of competitive advantage in 1980 by stating that competitive advantage is theconsequence of a successful competitive strategy:

Competitive strategy means 'taking offensive or defensive actions to create a dependable position in anindustry, to cope successfully with ... competitive forces and thereby yield a superior return on investmentfor the firm. Firms have discovered many different approaches to this end, and the best strategy for a givenfirm is ultimately a unique construction reflecting its particular circumstances'. (Porter)

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Note that Porter defines competitive advantage in terms of 'superior return on investment' rather thansimply superior sales or higher sales revenue.

4.2 The choice of competitive strategyPorter argued that selecting and implementing one of these strategies is the only way to effectively counterthe industry forces identified in his Five Forces model.

The diagram below summarises his argument.

Cost leader Stuck in themiddle Differentiator

High

profit

Low

profit

High

profit

Lower costs Higher costs Higher costs

x

Competitive pressures will increase as a market ages so that once the mature stage of the industry isreached only two competitive strategies will deliver competitive advantage (i.e. superior ROI).

Low cost: A firm following this strategy will withstand the shrinking margins better and so, as rivalsfall away, may be left as a major player with enhanced power against the power of suppliers andbuyers.

Differentiation: A firm presenting itself as a superior provider may escape price pressure by avoidingstraight-forward price comparisons with rivals.

A stuck in the middle strategy is one where the firm has sought to attract many segments at differentprice points and so is seen as not being as differentiated as the market leader but, perhaps because of thecosts of serving the differentiated segment, not able to make good profits at the cost leader's prices.

Worked example: PorscheA study by B&D Forecast released in German newspaper Welt am Sonntag earlier this week revealed thatPorsche, one of the most prestigious names in the automotive industry, is by far the most profitableautomaker on a vehicle by vehicle basis. Porsche makes an unheard of 21,799 profit on each car it sells!This isn't to say that Porsche is making 21,799 ($28,247 USD) straight up on every vehicle it makes, butrather that it earns variable profits, with some more (Cayenne Turbo S) and some less (Boxster). To seejust how badly Porsche blows other automakers out of the water, have a look at these figures. BMW makes2,475 ($3,207) for each car it sells a handsome figure, no question. Toyota pulls in an average of 1,684($2,182), while Audi makes 1,580 ($2,047). Daimler Chrysler (including Mercedes-Benz and Smart) makes708 ($917), and VW makes just 332 ($430) per vehicle. The study, which looked at the company'sfinances over 2005-2006 financial year, also revealed that Porsche sold 97,000 units and had a record gain of2.11 billion ($2.73 bn) before taxes.

Source: American Auto Press January 2007

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In 1995 the German luxury car maker Porsche was widely regarded as being on the car industry casualtylist. Its dependence on the US market exposed it badly to the recession following the stock market crash of1987.

It responded by launching two new cars:

The Porsche Boxster a 2-seater car selling at a lower price point than its war-horse car, the 911 butstill at a significant premium to other 2-seaters such as the Mazda MX5 and Rover's MGF

The Cayenne a sports utility vehicle aimed at family markets to rival the success of the Range Roverand Shogun SUVs but again at a substantial price premium to them

German wages are 6 to 7 times higher than other parts of Eastern Europe. Unlike other makers, includingBMW, VAG and Daimler-Benz, Ferrari, Lamborghini, and Aston Martin, it decided to retain the bulk of itsmanufacturing in its home country and built a substantial plant at Leipzig, Eastern Germany, in order toretain the 'Made in Germany' imprimatur.

In 2006/07 Porsche purchased 30.9% of Volkswagen Audi Group (VAG) to prevent it falling into the handsof corporate raiders and opening the possibility that Porsche would lose the benefit of close supply chainand technology sharing links with VAG. In the previous decade VAG had expanded beyond its VW (mid-market cars and vans) and Audi (premium cars) ranges to acquire a portfolio of cars brands includingexclusive niche brands Bentley and Bugatti, and budget brands Seat and Skoda.

he average profit per car between Porsche and VAG seems to underline Porter's distinctionerentiation and stuck in the middle competitive strategies.

4.3

4.3.1

4.3.2Comparing tbetween diff The Institute of Chartered Accountants in England and Wales, March 2009 215

Porter's three generic strategiesIllustrated in the diagram below:

Competitive basis

Low cost Differentiation

Broad Cost leadership Differentiation

Narrow Cost focus Differentiation focus

Cost leadership

A cost leadership strategy seeks to achieve the position of lowest-cost producer in the industry as a whole.By producing at the lowest cost, the manufacturer can compete on price with every other producer in theindustry, and earn the higher unit profits, if the manufacturer so chooses.

How to achieve overall cost leadership

(a) Set up production facilities to obtain economies of scale.

(b) Use the latest technology to reduce costs and/or enhance productivity (or use cheap labour ifavailable).

Competitivescope

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(c) In high technology industries, and in industries depending on labour skills for product design andproduction methods, exploit the learning curve effect. By producing more items than any othercompetitor, a firm can benefit more from the learning curve, and achieve lower average costs.

(d) Concentrate on improving productivity.

(e) Minimise overhead costs.

(f) Get favourable access to sources of supply.

(g) Use value chain to streamline activities and reduce non-value adding activities (see Chapter 5).

Classic examples of companies pursuing cost leadership are Black and Decker and South West Airlines.Large out-of-town stores specialising in one particular category of product are able to secure costleadership by economies of scale over other retailers. Such shops have been called category killers; anexample is Toys R Us.

Worked example: WatermarkWatermark is a supplier of catering and other services to airlines. It had a good six months in the first halfof 20X5, with revenue increasing from CU30.5m to CU35.2m and profits rising from CU1.6m to CU2.4m.John Caulcutt, the CEO, declared that the company's business was, in essence, finding savings in the airlines'supply chain: 'we can sell the savings to our clients and keep some of it for ourselves'.

4.3.3 Differentiation

A differentiation strategy assumes that competitive advantage can be gained through particularcharacteristics of a firm's products.

How to differentiate

(a) Build up a brand image (e.g. Pepsi's blue cans are supposed to offer different 'psychic benefits' toCoke's red ones).

(b) Give the product special features to make it stand out (e.g. Russell Hobbs' Millennium kettleincorporated a new kind of element, which boils water faster).

(c) Exploit other activities of the value chain (see Chapter 5).

4.3.4 Generic strategies and the Five Forces

Advantages Disadvantages

Competitiveforce Cost leadership Differentiation Cost leadership Differentiation

New entrants Economies of scaleraise entrybarriers

Brand loyalty andperceiveduniqueness areentry barriers

Substitutes Firm is not sovulnerable as itsless cost-effectivecompetitors to thethreat ofsubstitutes

Customer loyaltyis a weaponagainst substitutes

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Advantages Disadvantages

Competitiveforce Cost leadership Differentiation Cost leadership Differentiation

Customers Customers cannotdrive down pricesfurther than thenext most efficientcompetitor

Customers haveno comparablealternative

Brand loyaltyshould lower pricesensitivity

Customers mayno longer needthe differentiatingfactor

Sooner or latercustomersbecome pricesensitive

Suppliers Flexibility to dealwith costincreases

Higher marginscan offsetvulnerability tosupplier price rises

Increase in inputcosts can reduceprice advantages

Industry rivalry Firm remainsprofitable whenrivals go underthrough excessiveprice competition

Unique featuresreduce directcompetition

Technologicalchange will requirecapital investment,or makeproductioncheaper forcompetitors

Competitors learnvia imitation

Cost concernsignore productdesign ormarketing issues

Imitation narrowsdifferentiation

4.3.5 Focus (or niche) strategy

In a focus strategy, a firm concentrates its attention on one or more particular segments or niches of themarket, and does not try to serve the entire market with a single product.

Porter suggests that a focus strategy can achieve competitive advantage when 'broad-scope' businesses fallinto one of two errors:

Underperformance occurs when a product does not fully meet the needs of a segment and offers theopportunity for a differentiation focus player.

Overperformance gives a segment more than it really wants and provides an opportunity for a costfocus player.

Advantages

A niche is more secure and a firm can insulate itself from competition.

The firm does not spread itself too thinly.

Both cost leadership and differentiation require superior performance life is easier in a niche, wherethere may be little or no competition.

Drawbacks of a focus strategy

The firm sacrifices economies of scale which would be gained by serving a wider market.

Competitors can move into the segment, with increased resources (e.g. the Japanese moved into theUS luxury car market, to compete with Mercedes and BMW).

The segment's needs may eventually become less distinct from the main market.

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Worked example: MicrosoftAs discussed in a worked example in Chapter 5, Microsoft Corporation's success is largely attributed to itsoperating systems and, in particular, the Windows environment it has developed. Windows has undergonefour significant step changes of version in the past 15 years: the original Windows 3.1, Windows 98,Windows XP, and Windows Vista. Developers have designed each successive version on the premise thatthe PC user wishes to turn their machine into a one-stop communication and entertainment device and towork seamlessly between material on the local drive of their machine and other available resources on-lineand also able to present documents, show moving pictures and also play sound files. It must also have itsown security system. Therefore more and more features are bundled in that previously were boughtseparately from other providers.

The flagship Microsoft application is Microsoft Office. This too has moved through iterations premised onthe belief that users wish to manage their knowledge across many platforms from printed page to spokenword and Internet page.

During the past few years Microsoft has lost ground to two specific applications:

Linux a stand-alone operating system developed from Unix systems used on super-computers

Firefox a stand-alone Internet browser.

Both have the advantages of being free to download (but of course to do so the user has probably alreadybought Windows and has Microsoft's IE browser). Both are 'open source coding' which means that usersare a community and contribute to improving the programmes. The main attractions claimed by supportersof the systems seem to be their superior operational performance i.e. differentiation.

4.4 Conceptual difficulties with generic strategyIn practice, it is rarely simple to draw hard and fast distinctions between the generic strategies as there areconceptual problems underlying them.

Cost leadership

Internal focus: Cost refers to internal measures, rather than the market demand. It can be usedto gain market share: but it is the market share which is important, not cost leadership assuch.

Only one firm: If cost leadership applies cross the whole industry, only one firm will pursue thisstrategy successfully. However, the position is not clear-cut.

More than one firm might aspire to cost leadership, especially in dynamic markets wherenew technologies are frequently introduced.

The boundary between cost leadership and cost focus might be blurred.

Firms competing market-wide might have different competences or advantages that confercost leadership in different segments.

Higher margins can be used for differentiation: Having low costs does not mean you haveto charge lower prices or compete on price. A cost leader can choose to 'invest higher marginsin R&D or marketing'. Being a cost leader arguably gives producers more freedom to chooseother competitive strategies.

Differentiation: Porter assumes that a differentiated product will always be sold at a higher price.

However, a differentiated product may be sold at the same price as competing products inorder to increase market share.

Choice of competitor. Differentiation from whom? Who are the competitors? Do they serveother market segments? Do they compete on the same basis?

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Source of differentiation. This can include all aspects of the firm's offer, not only the product.Restaurants aim to create an atmosphere or 'ambience', as well as serving food of good quality.

Focus probably has fewer conceptual difficulties, as it ties in very neatly with ideas of market segmentation.In practice most companies pursue this strategy to some extent, by designing products/services to meet theneeds of particular target markets.

4.5 Bowman's strategic clockPorter's basic concept of generic strategies has been the subject of further discussion. Bowman's clockmodel was developed from surveys of practising managers attending MBA programmes who were asked todescribe the competitive strategies being followed by their own firms.

The strategy clock

1

2

3

4

5

6

7

8

Lowprice

Hybrid

DifferentiationFocuseddifferentiation

Strategiesdestinedfor ultimatefailure

High

Low

Low HighPrice

Perc

eive

dad

ded

valu

e

No frills

4.5.1 Price-based strategies

Strategies 1 and 2 are price-based strategies.

A no frills strategy (1) is aimed at the most price-conscious and can only succeed if this segment ofthe market is sufficiently large. This strategy may be used for market entry, to gain experience andbuild volume. This was done by Japanese car manufacturers in the 1960s.

A low price strategy (2) offers better value than competitors. This can lead to price war and reducedmargins for all. Porter's generic strategy of cost leadership is appropriate to a firm adopting thisstrategy.

4.5.2 Differentiation strategies

Strategies 3, 4 and 5 are all differentiation strategies. Each one represents a different trade-off betweenmarket share (with its cost advantages) and margin (with its direct impact on profit). Differentiation can becreated in three ways.

Product features Marketing, including powerful brand promotion Core competences

The pursuit of any differentiation strategy requires detailed and accurate market intelligence. Thecustomers and their preferences must be clearly identified, as must the competition and their likelyresponses. The chosen basis for differentiation should be inherently difficult to imitate, and will probablyneed to be developed over time.

The hybrid strategy (3) seeks both differentiation and a lower price than competitors. The cost base mustbe low enough to permit reduced prices and reinvestment to maintain differentiation. This strategy may bemore advantageous than differentiation alone under certain circumstances.

If it leads to growth in market share If differentiation rests on core competences and costs can be reduced elsewhere

Business strategy


If a low price approach is suited to a particular market segment Where it is used as a market entry strategy

The basic differentiation strategy (4) comes in two variants, depending on whether a price premium ischarged or a competitive price is accepted in order to build market share.

A strategy of focused differentiation seeks a high price premium in return for a high degree ofdifferentiation. This implies concentration on a well defined and probably quite restricted market segment.Coherence of offer will be very important under these circumstances. Johnson, Scholes and Whittingtongive the example of a department store offering a range of products to a variety of customer types butfailing to differentiate such matters as premises, dcor and staff according to the particular segment served.

4.5.3 Failure strategies

Combinations 6, 7 and 8 are likely to result in failure as there is little perceived added value to compensatefor the premium on price.

Interactive question 3: EuroFoods [Difficulty level: Exam standard]EuroFoods is a French-German consumer products group with a revenue of CU8 billion a year at 20X2retail prices. One of EuroFoods' activities is the manufacture of ice-cream.

Medley is an American company. It has worldwide sales of CU5 billion a year and these come mainly fromchocolate products. Three years ago Medley started to diversify. It did this by selling a new product, ice-cream, in one of its existing markets, Europe. Although Medley had no prior experience of ice-cream, itbelieved that it could exploit its existing expertise in food products, marketing and distribution in this newarea.

The European ice-cream industry revenue is CU6 billion at 20X2 retail prices.

Market share %EuroFoods 60Medley 10Local producers* 30

100

* These are defined as manufacturers who sell within only one European country.

Distribution has always been a very important aspect of the food industry. However, it is particularly so inthe ice-cream business. This is because the product must be kept refrigerated from factory to shop, andalso whilst it is stored in the shop.

Many of the shops which sell EuroFoods' ice-cream are small businesses and the freezer which is requiredfor storage is a costly item for them to buy. EuroFoods has therefore developed a scheme whereby it willinstall and maintain such a freezer in these shops. The shop owner does not have to pay for the freezer.The only condition which EuroFoods imposes is that the freezer must be used exclusively for the sales of itsproducts.

EuroFoods believes that this arrangement has worked well for everybody in the past. EuroFoods'expenditures on the freezers have ensured that its products have reached the consumer in good conditionand also enabled it to simplify inventory control. It has also played a part in building its market dominanceby enabling shops which otherwise would not be able to do so, to sell its products.

The European ice-cream business

The peak time of year for sales of ice-cream in Europe is from mid-June to mid-August. These summer salesare deemed 'impulse' sales by the trade and are traditionally made from small retail outlets whereEuroFoods tends to have its exclusive arrangements. The other sort of sale is the 'take-home', which arepurchases made in larger quantities at supermarkets. These outlets do not have exclusive agreements withEuroFoods.

Analysis of European ice-cream sales in 20X2 is as follows.

Volume Value Return on sales Profit before tax

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% CU billion CU billionImpulse sales 40 4 0.48Take-home sales 60 2 0.12Total 100 6

Medley

Medley would like to obtain its future growth from the 'impulse' sector of the market. It owns 14,000 non-exclusive freezer cabinets, mainly in the UK. However, it is costly to maintain these to sell the eightproducts which constitute its product range. Another problem is that in many cases small shops have roomfor only one freezer and this has often already been supplied by EuroFoods. As Medley's UK managingdirector said: 'It means only big competitors with a full range of products can enter the market'.

Medley would like to be able to place its products in the freezers provided by EuroFoods. However, whenit tried to do this two years ago in Spain, EuroFoods was successful in a legal action to prevent this.

Medley has now complained to the European Union that EuroFoods' exclusive freezer arrangementsrestrict competition and are unfair.

You are presently working for Thunderclap Newman, a merchant bank, as a business analyst in itsConfectionery Division.

Requirement

Write a report to the head of the Confectionery Division of your bank, which

(a) Identifies strategies which lead to competitive advantage.

(b) Makes recommendations to both companies on their possible future strategy options if the EUdecides that exclusive freezer arrangements are:

Anti-competitive and, in future, freezers should be available to any manufacturer

Not anti-competitive and EuroFoods can continue to protect the use of its freezers.

You should include a general explanation of how a firm may attain a competitive advantage.

Note: A billion equals one thousand million.


5 Product-market strategy: direction of growth

Section overview The second strategic choice, outlined in section 1 above, is which products and markets to serve.

Ansoff classifies the choices on a matrix into market penetration, product development, marketdevelopment and diversification.

Each strategy has its particular benefits and drawbacks.

5.1 Product-market growth matrixAnsoff drew up a growth vector matrix, describing how a combination of a firm's activities in currentand new markets, with existing and new products can lead to growth.

Business strategy


5.2 Growth vectorsAnsoff identifies four directions (or vectors) of growth available to the business. Unlike Porter's genericstrategies, where only one should be followed, management can pursue all four of Ansoff's vectors if itwishes to.

5.2.1 Market penetration

The firm seeks to do four things:

Maintain or to increase its share of current markets with current products, e.g. throughcompetitive pricing, advertising, sales promotion

Secure dominance of growth markets

Restructure a mature market by driving out competitors

Increase usage by existing customers (e.g. airmiles, loyalty cards)

The ease with which a company can pursue this strategy depends on its market and its competitors. If themarket is growing it may be relatively easy to gain share. However if markets are static (mature) it is not.

5.2.2 Market development: present products and new markets

There are many possible approaches. Here are some examples.

New geographical areas and export markets (e.g. a radio station building a new transmitter toreach a new audience).

Different package sizes for food and other domestic items so that both those who buy in bulk andthose who buy in small quantities are catered for.

New distribution channels to attract new customers (e.g. organic food sold in supermarkets notjust specialist shops, Internet sales).

Differential pricing policies to attract different types of customer and create new marketsegments. For example, travel companies have developed a market for cheap long-stay winter breaksin warmer countries for retired couples.

This strategy is likely to be more successful, the closer the characteristics of the new market are to existingmarkets (or segments).

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5.2.3 Product development: new products and present markets

This has several advantages.

The company can exploit its existing marketing arrangements such as promotional methods anddistribution channels at low cost.

The company should already have good knowledge of its customers and their wants and habits.

Competitors will be forced to respond.

The cost of entry to the market will go up.

5.2.4 Diversification: new products and new markets

Diversification occurs when a company decides to make new products for new markets. It shouldhave a clear idea about what it expects to gain from diversification.

Growth: New products and new markets should be selected which offer prospects for growth whichthe existing product-market mix does not.

Investing surplus funds not required for other expansion needs, bearing in mind that the funds couldbe returned to shareholders. Diversification is a high risk strategy, having many of the characteristicsof a new business start-up. It is likely to require the deployment of new competences.

Because of the extent of the change, diversification normally involves more risk than the other strategies.

5.3 Types of diversificationAnsoff identifies two classes of diversification:

1. Related diversification: Integrating activities in the supply chain or leveraging technologies orcompetences.

2. Conglomerate diversification: The development of a portfolio of businesses with no commercialsimilarity or links between them.

Current position

Vertical integration backward

Vertical integration forward

Conglomerate diversification

Horizontal integration

5.3.1 Related diversification

Horizontal integration is development into activities which are competitive with or directlycomplementary to a company's present activities.

Competitive products: Taking over a competitor can have obvious benefits, leading eventuallytowards achieving a monopoly. Apart from active competition, a competitor may offer advantages suchas completing geographical coverage.

Business strategy


Complementary products: For example, a manufacturer of household vacuum cleaners movinginto commercial cleaners. A full product range can be presented to the market and there may well bebenefits from having many of the components common between the different ranges.

By-products: For example, a butter manufacturer discovering increased demand for skimmed milk.Generally, income from by-products is a windfall to be counted, at least initially, as a bonus.

Vertical integration occurs when a company becomes its own supplier (backward) or distributorforward).

Backward integration: taking over responsibility for upstream processes e.g. a clothingretailer producing or designing its own clothes.

Forward integration: taking over responsibility for downstream processes e.g. an electricalgoods retailer setting up its own installation, servicing and repairs service.

Advantages of vertical integration

A secure supply of components or materials, hence lower supplier bargaining power

Stronger relationships with the final consumer of the product

A share of the profits at all stages of the value chain

More effective pursuit of a differentiation strategy

Creation of barriers to entry

Disadvantages of vertical integration

Over-concentration: A company places 'more eggs in the same end-market basket' (Ansoff).Such a policy is fairly inflexible, more sensitive to instabilities and increases the firm's dependenceon a particular aspect of economic demand.

The firm fails to benefit from any economies of scale or technical advances in theindustry into which it has diversified. This is why, in the publishing industry, most printing issubcontracted to specialist printing firms, who can work machinery to capacity by doing work formany firms.

5.3.2 Conglomerate diversification

Not very unfashionable in the USA and Europe where its financial returns have been disappointing,however, it has been a key strategy for companies in Asia, particularly South Korea.

Conglomerates

The characteristic of conglomerate (or unrelated) diversification is that there is no common thread,and the only synergy lies with the management skills. Outstanding management seems to be the key tosuccess as a conglomerate, and in the case of large conglomerates they are indeed able, because oftheir size and diversity, to attract high-calibre managers with wide experience.

Two major types of conglomerate can be identified. The financial conglomerate provides a flow offunds to each segment of its operation, exercises control and is the ultimate risk taker. In theory itundertakes strategic planning but does not participate in operating decisions. The managerialconglomerate extends this approach by providing managerial counsel and interaction on operatingdecisions, on the assumption that general management skills can be transferred to almost anyenvironment.

Advantages of conglomerate diversification

Risk-spreading: Entering new products into new markets offers protection against the failure ofcurrent products and markets.

High profit opportunities: An improvement of the overall profitability and flexibility of thefirm through acquisition in industries which have better economic characteristics than those of theacquiring firms.

Escape from the present business.

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Better access to capital markets.

No other way to grow.

Use surplus cash.

Exploit under-utilised resources.

Obtain cash, or other financial advantages (such as accumulated tax losses).

Use a company's image and reputation in one market to develop into another where corporateimage and reputation could be vital ingredients for success.

The example of Virgin Group above may be an example of conglomerate diversification.

Disadvantages of conglomerate diversification

The dilution of shareholders' earnings if diversification is into growth industries with high P/Eratios.

Lack of a common identity and purpose in a conglomerate organisation. A conglomerate willonly be successful if it has a high quality of management and financial ability at central headquarters,where the diverse operations are brought together.

Failure in one of the businesses will drag down the rest, as it will eat up resources.

Lack of management experience: Japanese steel companies have diversified into areas completelyunrelated to steel such as personal computers, with limited success.

Poor for shareholders: Shareholders can spread risk quite easily, simply by buying a diverseportfolio of shares. They do not need management to do it for them.

The methods by which Ansoff's growth strategies can be implemented (e.g. organic growth, acquisitionetc) will be considered in Chapter 10.

Interactive question 4: Blue Jeans Group [Difficulty level: Exam standard]Note: Assume that the current date is March 20X9.

The Blue Jeans Group was floated in March 20X4 on the Alternative Investment Market with a capitalisationof over CU22 million. The company was founded eleven years earlier by three Kenyan Asian brothers whobegan their venture with a stall on the King's Road market.

Eight years prior to flotation, the business had been built up to such an extent that the brothers wereforced to choose between the wholesaling and retailing arms of their operation. In the event, they decidedto focus their effort on the faster-growing wholesaling activities. The capital released by the sale of the retailoutlets was then used to purchase a warehouse near to the King's Road to stock the garments. It was atthis time that the decision was taken to develop Blue Jeans as the brand name for the range of jeans andfully co-ordinated casual wear in which they were trading.

When the brothers began their wholesaling operations, the rapid growth in the market for jeans meant thattheir largest competitors had full order books and were not in a position to satisfy market demand.Therefore there was plenty of 'market room' for a company like Blue Jeans. The brothers decided toconcentrate their effort initially on smaller retailers, since many of these were not being adequately sourcedby the larger (mainly US) manufacturers.

Eventually contracts were obtained with John Lewis and the Burton Group, among others. The smallretailer was not ignored but, as Blue Jeans grew, it was forced to direct its efforts towards the moreestablished shops rather than market traders.

Manufacturing sourcing policy

In the first instance Blue Jeans turned to Hong Kong to obtain the larger quantities which it required for itsexpanding business. It generally takes seven or eight months for a new manufacturing unit to attain thestandards which are demanded by Blue Jeans. Around 90 per cent of the company's orders are nowproduced in Hong Kong. Blue Jeans considers that its policy of contracting out the manufacture of itsgarments has generally been successful. However, recent delays in producing new styles of jeans from newpatterns have caused problems.

Business strategy


Currently Blue Jeans is radically restyling part of the BSCO brand and hopes to take the market by surprise.A contract to produce the first batch of 5,000 pairs of the new design is about to be awarded. Twocompeting tenders are being considered.

Supplier A An existing Hong Kong based supplier, offering to deliver the garments in three to sixmonths' time at a cost of CU10 per pair payable on delivery.

Supplier B A new supplier to Blue Jeans, which in the past has worked almost entirely for one of itssmaller competitors. Supplier B is offering to produce the jeans at CU9 per pair payable inadvance. It will deliver in nine months and will pay a penalty fee of CU0.50 per garment permonth for any late deliveries.

On only one occasion has Blue Jeans become involved in the manufacture of its own garments. Theoutcome of which was near disastrous. The experience led the brothers to make two important policydecisions.

First, they decided not to go into manufacturing themselves but to concentrate on buying and selling.Secondly, they decided to stick with experienced manufacturers and not to attempt to obtain too great adegree of manufacturing process innovation. Recent changes in textile industry technology, e.g. flexiblemanufacturing, JIT, etc, have led one of the brothers to question this approach.

Product market strategy

During the past decade considerable changes have taken place in the jeans market. Therefore flexibility andability to respond to fairly rapid changes in fashion are an essential component of the ability of a company,such as Blue Jeans, to survive in the jeans business.

The current jeans product strategy of Blue Jeans is based upon a portfolio of four brand names, each ofwhich has its distinctive appeal and identity. First, there is the Blue Jeans brand itself. This is the originalbrand and is the leader in the group's international activities. The Blue Jeans brand, which is targeted atfashion-conscious men and women in the 15-25 age bracket, consists of two main elements. There are basicdenim jeans which are offered on an all the year round basis and there is a casual collection offered on aseasonal basis. The jeans brand is from time to time strengthened by the addition of jeans-related products.These have included footwear, marketed under licence, leather jackets and a range of accessories such asbelts and watches. It is envisaged that bags, holdalls and grips will also be introduced.

The Big Stuff Company brand (BSCO) is more 'classical' leisurewear with more contemporary fashions. TheBSCO brand is aimed at both men and women in the 16-25 age group. The Buffalo brand, which wasdesigned in Bordeaux initially for the French market, has its own distinctive French flavour. Moreover, itssales are biased heavily towards women, although it caters for both sexes in the 16-24 age group. Bycontrast, Hardcore is tough and masculine, based upon a traditional 'macho' image. Since it was introducedit has developed its own clearly defined niche within the men's jeans market namely the 16-35 age group.

Company financing

The development of Blue Jeans during its early years was reflected in a steady expansion in its revenue andprofitability. However, five years on, losses were incurred due to a number of unfortunate events. By the20X2/X3 financial year profitability had recovered and had reached a total of almost CU1 million. In orderto maintain growth in March 20X4 five and a half million shares, representing almost one quarter of thegroup's equity, were sold at 100p on the Stock Exchange. This sale raised over CU5m for investmentpurposes.

Since the floatation of the Blue Jeans Group in March 20X4, the company has gone from strength tostrength, with average sales growth being roughly 50 per cent per annum. (The Appendix contains BlueJeans' financial details). Turnover in the year ending 31 March 20X9 is expected to be over CU100 millionwith profits of over CU10m. The brothers are keen to maintain this record of sales growth, while at thesame time providing the highest possible returns to their shareholders.

The jeans market

During 20X4 a revival in the jeans market occurred, stimulated by Levi's successful reintroduction of its fivepocket, fly button 501 jeans. This development, backed by a heavy advertising campaign, may be seen interms of a more general appeal to nostalgia in society which was prevalent at that time. A craze for stone-

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washed jeans also helped to boost sales temporarily. However, this fad had fizzled out by 20X7, by whichtime overall sales were again static.

A more important trend during the mid to late 20X0s was for the jeans market to become increasinglyfashion conscious. Traditionally the style of jeans has changed relatively slowly and manufacturers haverelied on making standardised products at high volume. This has tended to accentuate the importance ofproduction economies of scale.

Jeans market 20X6

United States (490m pairs) Europe (180m pairs)Levi Strauss 24% Levi Strauss 11%Lee 14% Wrangler 3%Wrangler 10% Lee 2%Guess 3% Lee Cooper 2%Others 49% Blue Jeans 2%

Others 80%

More recently, rapid changes in style have required companies to exhibit greater flexibility. Designer jeancompanies, such as Blue Jeans, have generally done well. Of the major manufacturers, Levi and Lee haveprospered. By contrast, Wrangler and Lee Cooper have suffered from their 'cowboy' and 'old fashioned'images respectively.

In an attempt to reverse the adverse trend, Wrangler initiated a major TV advertising campaign. Thisfollowed an expansion of such activity by Levi and Blue Jeans. Each of the campaigns had one factor incommon targeting of adolescents, the chief consumer of jeans.

A common feature of the strategic response of the major manufacturers to their business environment hasbeen a decision to withdraw from manufacturing and source their output from contract manufacturers inthe Far East. The unquestioned European leader in this respect has been Blue Jeans.

APPENDIX

Blue Jeans Ltd financial details

Blue Jeans: Five year trading summary

20X8 20X7 20X6 20X5 20X4CU'000 CU'000 CU'000 CU'000 CU'000

Revenue 97,461 72,241 50,242 31,113 19,906Profit on ordinary activities before taxation 12,756 8,399 5,905 4,208 2,633Taxation 5,019 2,867 2,010 1,718 1,177Profit on ordinary activities after taxation 7,737 5,532 3,895 2,490 1,456Minority interests 240 180 160 47 36

7,497 5,352 3,735 2,443 1,420Earnings per share 31.9p 22.8p 15.9p 10.4p 7.8p

Requirements

(a) Outline the factors Blue Jeans should consider in awarding the contract to produce the first batch ofthe new style BSCO jeans.

(b) As a management consultant, prepare a memorandum to the managing director which

(i) Performs a corporate appraisal of Blue Jeans at March 20X9.

(ii) Analyses its future strategy options. In discussing future strategy options, the memorandumshould deal, inter alia, with vertical integration, market development and product.


Business strategy


6 Other strategies

Section overview The growth strategies identified by Ansoff involve essentially successful business divisions.

Where divisions are less successful there are strategic choices involving letting them go.

6.1 WithdrawalWithdrawal may be an appropriate strategy under certain circumstances.

Products may simply disappear when they reach the end of their life cycles.

Underperforming products may be weeded out.

Sale of subsidiary businesses for reasons of corporate strategy, such as finance, change of objectives,lack of strategic fit.

Sale of assets to raise funds and release other resources.

Exit barriers may make this difficult and/or costly.

Cost barriers include redundancy costs, termination penalties on leases and other contracts, and thedifficulty of selling assets.

Managers might fail to grasp the idea of decision-relevant costs ('we've spent all this money, so wemust go on').

Political barriers include government attitudes. Defence is an example.

Marketing considerations may delay withdrawal. A product might be a loss-leader for others, or mightcontribute to the company's reputation for its breadth of coverage.

Psychology. Managers hate to admit failure, and there might be a desire to avoid embarrassment.

People might wrongly assume that carrying on is a low risk strategy.

Worked example: Plastics at GEThe following extract [from The Economist, January 2007] illustrates the importance of the industry lifecycleon investment and divestment decisions.

'When General Electric's legendary boss Jack Welch first joined the firm, he worked in an office on PlasticsAvenue. Mr Welch's talent for management was noticed when, as head of the Plastics Division, he doubledits size in three years. But today plastics is a low growth commodity business. As if to prove that JackWelch's successor, Jeffrey Immelt, has put the plastics division up for sale.

The sale is Mr Immelt's latest attempt to please shareholders who have been strikingly unenthusiastic sincehe took charge in 2001. Mr Immelt has promised to return more money to the shareholders. He has beenshuffling GE's portfolio to boost growth. In a string of deals worth over $100 billion so far, GE has boughtfast-growing firms in health care, biosciences and Hispanic entertainment and sold its under-performingindustrial materials, insurance and motors businesses.'

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6.2 Divestment and demergerDivestment and demerger have become more common as companies seek to reverse the diversificationstrategies they once pursued. There are several reasons for this.

To rationalise a business as a result of a strategic appraisal, perhaps as a result of portfolio analysis,where a lack of fit has been identified. Another reason might be to free up management time toconcentrate on core competences and synergies.

To sell off subsidiary companies at a profit, perhaps as an exit route after managing a turn-round or asa management defence strategy to avoid a potential take-over of the whole company.

To allow market valuation to reflect growth and income prospects. Where a low growth, steadyincome operation exists alongside a potentially high growth new venture, the joint P/E is likely to betoo high for the cash cow and too low for the star. The danger is that a predator will take over thewhole operation and split the business in two, allowing each part to settle at its own level.

Satisfy investors: diversified conglomerates are unfashionable. Modern investment thinking is thatinvestors prefer to provide their own portfolio diversification.

To raise funds to invest elsewhere or to reduce debt.

Worked example: PhilipsPhilips, the Dutch manufacturer of consumer electronics, divested some non-core businesses in order toconcentrate on core businesses as a strategy for improving profitability. It sold its production of whitegoods (large kitchen appliances) to an American firm, Whirlpool. There was overcapacity in the market.Philips was suffering from declining profitability and did not have the resources to invest in all its productranges.

Demerger can realise underlying asset values in terms of share valuation. ICI's demerger of its attractivepharmaceuticals business led to the shares in the two demerged companies trading at a higher combinedvaluation than those of the original single firm.

Worked example: UnileverUnilever chose to focus on 400 of its brands with the greatest potential. It switched resources away fromthe remaining 1,200, either by disposing of them as they had no future, harvesting them and allowing themto decline over time, or for a third group simply stopping their marketing so that they became moreprofitable.

Business strategy


Summary and Self-test

Summary

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Self-testAnswer the following questions.

1 Define corporate appraisal.

2 How can it be used to guide strategy formulation?

3 What is gap analysis?

4 What is required for a successful cost leadership strategy?

5 How do you differentiate?

6 Draw Ansoff's growth vector diagram

7 Explain two alternative strategies for existing products or markets that can be pursued.

8 Explain how a producer of natural spring water could attempt to gain a competitive advantage over itsrivals giving specific examples.

9 If a tennis racquet manufacturer began selling a line of tennis clothing, what sort of growth would thisbe in terms of Ansoff's matrix? Suggest two ways in which such development could be achieved.

10 Hannafords Dairy Ltd

Hannaford's Dairy Ltd (Hannafords), operates a 'door step' fresh milk delivery service. The company isone of your firm's clients. Recently the directors have been concerned about the company's future.This is partly because the directors intend to sell the company for the maximum value, and retire, inabout five years' time. You have been asked to assess the current position and make recommendationsfor the future strategic direction of the company. The company's stated objective is 'to provide thebest possible service to our customers.'

Hannafords was formed in the early 1960s by two brothers when they inherited a 'door step' milkdelivery business from their father. Immediately before the father's death the business had amountedto three 'milk rounds' which the father and the two sons carried out. The relatively small amount ofadministrative work had been undertaken by the father. The business operated from a yard on theoutskirts of Mungla, a substantial town in the far south west of Bangladesh.

Hannafords expanded steadily until the early 1980s, by which time it employed 25 full-time roundsstaff. This was achieved because of four factors.

(1) Some expansion of the permanent population of Mungla(2) By expanding Hannafords' geographical range to the villages surrounding the town(3) An expanding tourist trade in the area(4) A positive attitude to 'marketing'.

As an example of the marketing effort, the arrival of a new residents into the area is reported back bythe member of the rounds staff concerned. One of the directors immediately visits the potentialcustomer with an introductory gift, usually a bottle of milk and a bunch of flowers, and attempts toobtain a regular milk order. Similar methods are used to persuade existing residents to place ordersfor delivered milk.

By the mid-1980s Hannafords had a monopoly of door-step delivery in the Mungla area. Acombination of losing market share to Hannafords and the town's relative remoteness had discouragedthe national door-step suppliers. What little locally-based competition there once was had gone out ofbusiness.

Supplies of milk come from a bottling plant, owned by one of the national dairy companies, which islocated 50 miles from Mungla. The bottlers deliver nightly, except Saturday nights, to Hannafords'depot. Hannafords deliver daily, except on Sundays.

Hannafords bought and developed a site, for use as a depot, on the then recently established MunglaTrading Estate in 1970. This was financed by a secured loan which the company paid off in 1985. Thedepot comprises a cold store, a parking area for the delivery vans, a delivery van maintenance shopand an office.

Business strategy


Profits after adjusting for inflation, have fallen since the early 1980s. Volumes have slipped by about athird, compared with a decline of about 50% for door-step deliveries nationally over the same period.New customers are increasingly difficult to find, despite a continuing policy of encouraging them. Manyexisting customers tend to have less milk delivered. A sufficient profit has been made to enable thedirectors to enjoy a reasonable income compared with their needs, but only by raising prices.Currently Hannafords charges 40 pence for a standard pint, delivered. This is fairly typical of door-stepdelivery charges around Bangladesh. The Mungla supermarket, which is located in the centre of town,charges 26 pence a pint and other local stores charge between 35 pence and 40 pence.

Currently, Hannafords employs 15 full-time rounds staff, a van maintenance mechanic, asecretary/bookkeeper and the two directors. Hannafords is regarded locally as a good employer. Thecompany pays good salaries and the directors have always taken a 'paternalistic' approach to theemployees. Regular employment opportunities in the area are few. Rounds staff are expected to, andgenerally do, give customers a friendly, cheerful and helpful service.

The two brothers continue to be the only shareholders and directors, and comprise the only level ofmanagement. One of the directors devotes most of his time to dealing with the supplier and withissues connected with the rounds. The other director looks after administrative matters, such as theaccounts and personnel issues. Both directors undertake rounds to cover for sickness and holidays.

Requirements

(a) Comment on the company's stated objective ('to provide the best possible service to ourcustomers') as a basis for establishing a corporate strategy. (2 marks)

(b) As far as the information given in the question will allow, undertake an analysis of the strengths,weaknesses, opportunities and threats (SWOT analysis) of the company.

You should explain each point you make and provide some indication of the importance whichyou attach to each.

Indicate what additional information you would need to obtain and why you need it, to enableyou to complete your SWOT analysis. (16 marks)

(c) Indicate how the resources of the company could form the basis of its future strategy. (6 marks)

(24 marks)

11 Kraun Shipping Ltd

Kraun Shipping Ltd ('KShipping') is a major UK listed company which has four wholly-ownedsubsidiaries: Kraun Ports Ltd ('KPorts'), Kraun Logistics Ltd ('KLogistics'), Kraun Ferries Ltd('KFerries') and Kraun Cruises Ltd ('KCruises').

KCruises is the fourth largest ocean cruise company in the world, operating 15 cruise liners andholding a 15% share of the market. Currently the board of KShipping is considering whether to accepta CU2,600 million cash offer for KCruises from the market leader in the ocean cruise industry,Feyestar Cruise Corporation ('Feyestar'), a US based company which controls 30% of the market.However, two other strategies are being considered by the KShipping board: first, to form a strategicalliance between KCruises and the cruise industry's second largest operator, Windees CruiseCorporation ('Windees'); and, second, float KCruises, issuing shares pro rata to the existing investorsin KShipping. This latter policy would leave it entirely up to shareholders to decide whether to acceptthe bid from Feyestar or, alternatively, to opt for an effective merger with Windees or to retainKCruises's independent existence.

The industry background

Although the market for ocean cruise holidays only accounts for 5% of the world tourist industry, it isone of the fastest growing sectors. Throughout the past decade the number of cruise passengerscarried increased by between 10% and 15% each year. Because of this rapidly increasing demand, themajor cruise holiday operators are aiming to increase their capacity by 60% between 2006 and 2011,expanding the number of berths available from 195,000 to nearly 315,000. As a result, in the spring of2006 orders had been placed for the construction of no fewer than 60 new liners, worth someCU14,000 million.

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Currently there are four major ocean cruise operators, together accounting for 90% of the holidayssold. The largest is Feyestar, with a 30% share of the market, followed by Windees with 25%. A thirdcompany has a 20% share of the market, and KCruises controls 15%. The Big Four have grown bothorganically and by acquisition, and consequently the number of small independent operators in theindustry has declined. Moreover, some companies which have tried to break into the industry, offeringnew destinations and/or selling direct rather than through travel agents, have found the going tough,generally selling out to the larger operators after surviving for only one or two years. The largecruising companies have also tried to entrench their positions by forging alliances with travel agentsand the large holiday companies which operate at the international level.

No less than two thirds of all cruise passengers are North American, reflecting the fact that cash-richearly retirees nowadays actively seek out leisure opportunities. The next largest market is the UK,although British nationals taking ocean cruising holidays only account for around 8.5% of the worldtotal. The most popular destination by far is the Caribbean, accounting for 45% of all cruise holidaystaken, followed by Mediterranean cruises, which account for another 12.5%. Other increasinglypopular destinations are Alaska, the Pacific coast of Central America, and Northern Europe and theBaltic. Efforts are being made to develop new holiday cruises based in Brazil and Singapore.

Risk exposure in the industry is relatively high as capacity is more or less fixed in the short term, andthe interval between ordering and commissioning a new cruise liner is 2-3 years. On the other hand,demand for cruising holidays can decline sharply when there is an economic recession.

The company profile

Even before the bid from Feyestar for KCruises, the board of KShipping had been considering trying tofocus more on its three UK-based core activities: ports, ferries and logistics. An analysis of its activitiesover the past five years shows the following:

Years ending 31 December 2003 2004 2005 2006 2007 (projected)CUm CUm CUm CUm CUm

RevenuePorts, ferries and logistics 2,650 2,600 2,280 2,820 2,795Cruise holidays 820 975 1,110 1,275 1,325

3,470 3,255 3,710 4,095 4,120Net profitPorts, ferries and logistics 225 120 220 100 90Cruise holidays 110 135 165 145 150

335 255 385 245 240Net assetsPorts, ferries and logistics 3,850 4,030 4,160 3,850 3,960Cruise holidays 855 1,050 1,325 1,910 1,470

4,705 5,080 5,485 5,760 5,430

The board meeting

At a recent board meeting the chief executive officer (CEO) of KShipping suggested that Feyestar'sCU2,600 million offer for KCruises undervalued the latter by some CU550 million. It appeared thatFeyestar was assuming a 4% per annum growth rate in projected earnings for 2007 of CU150 million,which seemed to be on the low side. However, if Feyestar were to acquire KCruises, it would have topay Windees CU200 million in compensation for terminating an existing (but limited) joint venturearrangement between KCruises and Windees.

The chairman felt that, as KShipping was a public listed company, it was necessary to consider therelative advantages and disadvantages of each of the three strategic options (take-over of KCruises oreven KShipping by Feyestar; forming a much closer strategic alliance between KCruises and Windees;demerging KCruises from the KShipping group and floating it on the Stock Exchange). In particular, hewanted an appraisal of the competitive environment in the ocean cruising industry, KShipping's corecompetences, the generic strategies facing the group, and how growth might be best achieved.

The finance director of KShipping was concerned that risk exposure would be significantly increasedif the much closer strategic alliance between KCruises and Windees went through. This was becausethe group would be more heavily committed to ocean cruising, most of whose passengers were North

Business strategy


American. Moreover, there would be further exposure to foreign exchange risk insofar as orders fornew cruise liners had been placed with overseas shipyards.

Requirement

As an assistant to the finance director, prepare a memorandum for the board which briefly examineseach of the following matters:

The competitive environment in the ocean cruising industry, using an appropriate analyticalframework such as Porter's 5 forces model.

How the competitive advantage enjoyed by KShipping might be assessed (e.g. by analysing thegroup's core competences).

How growth might be best achieved by KShipping.

The impact on the risk exposure of the KShipping group if the much closer strategic alliance withWindees were to go through. (33 marks)

Note: Ignore taxation.

12 Juniper Ltd

Juniper Ltd retails middle-of-the range women's wear through a chain of 200 shops located in the UK.The clothes sold carry their own labels and those of other fashion houses. The company's financialyear ended on 31 January, and the following are key statistics relating to its operations over the pastsix years.

20X2 20X3 20X4 20X5 20X6 20X7Number of shops 235 240 230 220 200 200Employees 5,600 5,400 5,200 5,000 4,800 4,600Revenue (CUm) 360 380 400 420 440 460Pre-tax profit(CUm)

36 4 45 38 22 18

The history of the companyJuniper Ltd was founded 25 years ago and, after a successful flotation on the stock market 10 yearsago, the business continued to expand rapidly. However, its share of the middle-of-the-range women'swear market is still relatively small. Management accounts for the first quarter of 20X7/X8 have showna further reduced profit. The board has recently met to consider various strategies which could turnround the company.

The industry profileAt the top end of the market are the fashion houses, which concentrate on design and promotethemselves through magazines. Their designs are adapted for wider distribution through so-called'diffusion label' collections, and these are sold with accessories through chains of department stores.There they compete with other labels targeted at niche markets and which are owned by textilemanufacturers or by independent non-manufacturing (and generally smaller) listed companies. Some ofthe latter sell through their own stand-alone retail outlets, as well as through shops-within-shops.

At another level are 'mass brands', each catering for a slightly different segment of the market (e.g.depending on customers' ages, incomes and sizes) or offering specific lines (e.g. maternity, leisure, orsports wear). Some of these clothes are sold via specialist chains owned by large companies or bysmaller independents. There are also clothing department stores which carry a broad range of lines. Afeature of the industry is the considerable variation in the ways in which the different companiesoperate. Some chains concentrate on women's clothing and offer only one format. Others have astandard format but sell both men's and women's clothing. Yet others comprise chains of differenttypes of shop, each catering for a niche market. Several groups supplement their high street trade byselling via catalogues, and department stores clearly combine selling clothes with other activities,although some of the fashion-oriented companies focus on a very narrow range of complementaryproducts (e.g. on soft furnishings and interior design).

The diversity of approach is reflected by the fact that the size of different companies variesconsiderably. There are some small privately-owned local outfitters, catering for the needs of aparticular clientele. Conversely, there are the specialist chains run by privately-owned groups or by

STRATEGIC OPTIONS


6

relatively small listed companies. Further up the scale are medium-sized companies, while at the topend are the largest groups which operate department stores.

Few of the fashion retailers manufacture their own clothes, preferring to be able to switch suppliersand exercise buyer power as much as possible. Consequently vertical integration is not generallyregarded as a helpful attribute. However, perhaps the main problem facing clothing retailers is the factthat there are few barriers to entry. Partly because of this they are forever jockeying for position in anintensely competitive industry, and profit records tend to be highly volatile. A relative advantage,brought about by innovation, can soon be lost, and there have been numerous examples over theyears of smaller (but listed) textile manufacturers and fashion retailers collapsing. Equally, several ofthe larger companies have had to be turned round with radical shake-ups in the ways in which they areorganised and run. It is therefore necessary to maintain as much flexibility as possible to respondrapidly to changes both in consumer tastes and in the competitive environment.

The options facing Juniper Ltd

At the recent board meeting called to review performance for the three months ended on 30 April20X7, the company's sales director argued that pre-tax contribution per square foot was too low andthat what was needed was an increase in sales volume. This could only be secured by carrying morelines and by cutting prices. If necessary this would have to be achieved by moving down-market andselling cheaper lines to a more broadly based clientele. The finance director disagreed. She took theview that it might well be better to develop the company's existing niche in the market place and tryto increase margins.

The design and purchasing director tended to agree with the finance director. In particular, she was ofthe opinion that a high profile designer should be commissioned to come up with a new collection, andthat the clothes should be strongly marketed by employment supermodels to promote them inadvertisements in the leading fashion magazines. At the same time it was desirable to freshen up theformat of the shops.

The chairman felt that various other options should be considered by the board. One possibility wasto link up with a US fashion chain, and one American company in particular had already shown interestin such an association. Another option was to develop different fashion lines using new labels whichwould appeal to customers not attracted by the company's present range of clothes. Otherpossibilities included closing some of the stand-alone retail outlets and opening up more shops-within-shops, selling men's clothes alongside women's fashions, selling more accessories, or even a limitedrange of soft furnishings, developing a mail order business, and integrating vertically by manufacturingclothes.

In view of the difference in views among board members, it was decided to commission a preliminaryreport reviewing the strategic options open to the company.

Requirement

As an outside consultant, prepare briefing notes for the board of Juniper Ltd which examines andevaluates each of the strategic options open to it. The notes should deal only with the followingoptions.

Moving downmarket, cutting margins and increasing sales volume

Moving upmarket with a new designer collection, increasing margins, and changing the format ofthe shops

Linking up with an overseas fashion retailer

Extending the range of clothes sold by introducing new labels

Switching to shop-within-shop retail outlets

Diversifying (e.g. into men's clothing, fashion accessories, soft furnishings, mail order, etc)

Integrating vertically by manufacturing clothes. (33 marks)

Now, go back to the Learning Objectives in the Introduction. If you are satisfied that you have achievedthese objectives, please tick them off.

Business strategy


Answers to Self-test

1 A critical appraisal of strengths, weaknesses, opportunities and threats.

2 Match strengths with market opportunities; convert weaknesses into strengths and threats intoopportunities.

3 Comparison of the objective with the outcomes of already-planne

chap - 6 strategic options

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