Unit-4

Strategy Formulation
 Concept of Strategy Formulation
• Strategy formulation is the process of decision
making in order to define a firm’s strategy
• Business firms use more formalized, analytical
processes while formulating strategies
• In the formulation process, it is necessary to
identify strategic issues that a firm will face in
the future
• It makes it easy to use resources and
competency to address different difficulties in
a changing situation
 Definition of Strategy Formulation
Pearce and Robinson: “strategy formulation is
designed to guide executives in defining the
business their company is in, the aims it seeks,
and means it will use to accomplish these
aims… strategy formulation combines a
future-oriented perspective with concern for a
firm’s internal and external environments in
developing its competitive plan of the action”
 Process of Strategy Formulation
1. Definition of company mission: formulation of an
effective strategy is based on a clear definition of
company mission, an accurate appraisal of the external
environment, and a thorough internal analysis of the firm
2. Assessing external environment: evaluating PEST and
competitive position, customer profile, reputation among
suppliers and creditors, labor market environment
3. Industry analysis: the essence of strategy formulation is
coping with nature and degree of competition in an
industry
4. Environmental forecasting: the crucial responsibility for
strategists will be ensuring their firm’s capacity for
survival. This will be done by forecasting and adapting to
environmental changes in ways that provide new
opportunities for growth and profitability
5. Internal analysis of the firm: it is done to identify
the strategically important organizational strengths
and weaknesses (financial, personnel, marketing,
production and operation)
6. Formulation long-term objective: long term
objectives are the results a business seeks to
achieve over a specified period of time, long term
objectives are profitability, productivity, competitive
position, employee development and technology
leadership
7. Strategic analysis and choice: while making
strategic choice the alternative strategy may be
incremental or creative. Incremental strategies are
normally developments or alternations of past
strategies whereas innovative strategies are newly
developed strategic alternatives
 A resources-based view to strategy formulation
• Resources are the input in the production
process. Capability is the capacity of
performing some tasks using the resources
• the strategy should be based upon the
resources which are difficult to identify,
imperfectly transferable and difficult to
imitate
• The resources and capabilities should be
developed to meet the trend in the general
environment
• The resources and capabilities necessary to
address future competitive challenges should
also be built up
 Generic competitive strategies
• Cost leadership strategy
• Differentiation strategy
• Focus strategy
Cost leadership strategy
 Cost leadership strategy v
• To produce acceptable goods or services for
customers at the lowest cost relative to that of
competitors
• To offer standardized products at lower price
• To reduce cost and increase the market share
• To increase profit
• Successful when the customers are price
sensitive
 Ways of cost reduction
1. Economics of scale
2. Capacity utilization
3. Experience
4. Resource sharing
5. Low cost material
6. Direct marketing
7. Simple product design and process
 Conditions of success of cost leadership
strategy
1. High price competition
2. Standardized products
3. Price sensitive customers
4. Similar products
5. Low switching cost
6. High buyer power
 Benefits of cost leadership strategy
1. Minimization of competitive pressure
2. Low risk of substitution
3. Less chance of new entrants
4. Increase in market share
5. Address to customers bargaining
Limitations of cost leadership strategy
1. Low profitability
2. Risk of imitation
3. Decrease in demand
4. Development of new technology
5. Need of heavy investment
Differentiation strategy
 Differentiation strategy v
• Produce goods or service (acceptable cost)
that customers perceive as being different in
ways that are important to them.
• Organisation tries to offer the products which
are distinct in the perception of customers.
• Differentiation may be product parameters,
services back up, promotion and image.
 Bases of differentiation
1. Unique product performance and features
2. Unique services
3. Detailed information
Benefits of differentiation strategy
1. Reduce competitive pressure
2. Increase brand loyalty
3. Difficult to enter new firms
4. Low chance of substitution
5. Customer’s satisfaction
6. Ready to pay premium price
Limitations of differentiation strategy
1. High chance of failure
2. Customers may not value differentiation
3. Extensive research and development
Focus strategy
 Focus strategy
• Integrated set of actions taken to produce goods
and services that serve the needs of a particular
competitive segment.
• Segment on buyers’ group, segment on product
line and geographic market
• Focuses on narrow segment of customers.
• Firm attempts to achieve either cost advantage or
differentiation.
• Firm focuses on market segment with high
profitability and growth.
 Benefits of focus strategy

1. Understand needs of the customers better

2. High customer loyalty
3. Difficult for the competitors to enter
4. Develop new capabilities
Limitations of focus strategy
1. Market segment might change
2. May attract competitors
3. Needs and taste may change
• Introduction: slow growth & high cost per unit,
research & development cost of production is
high, will use a focused strategy, profit is
reinvested, require significant amount of capital
• Growth: sales increase rapidly, to reap the
benefits of economies of scale, higher profit
which may attract new firms, needs to spend
more in marketing to enhance customer loyalty,
require significant amount of capital, need
research & development funds, adopt market
development strategy
• Maturity: sales & profit gets slow, rivalry
compete on price basis, some firms begin to
exit, benefited from product innovation or
finding new customer markets
• Decline: sales & profit decrease rapidly,
customer loyalty shifts to other products,
competition is totally based on price, firms
exit the industry rapidly, consolidation
strategy should be applied
 Strategic Clock Oriented Market
based strategies v
• Bowman and Faulkner in 1996.
• It is important to understand how companies
compete in the marketplace.
• Can choose possible strategy based on the
available competencies
1. No Frills (low price/low value): combination of
low price with low perceived added value,
focuses to price sensitive customers, products
are inferior but the prices are attractive enough
to convince consumers, firms do not usually
choose to compete in this category
2. Low price: combination of low price with similar
perceived added value as the competitors,
competing in this category are the low cost
leaders, sustain with very low margins and high
volume
3. Hybrid: It is the combination of low price with
differentiation , customer perceives high value with
low price, companies build reputation of offering fair
prices for reasonable goods, discount department
store is an example of this category, this can build
customer loyalty
4. Differentiation: It aims to offer products and services
having unique characteristics, can be with or without
price premium, it offers high perceived- value to the
customers, companies either increase their price and
sustain themselves through higher margin or keep
their price low and seek greater market share,
branding is important
5. Focused differentiation: It combines high
price with high perceived value and focuses on
a particular segment ,the product may not
have real value any more but the perception
of customers is enough to change very high
premium, the market is highly targeted and
margins are also high
6. Increased price/ standard product: It
combines high price with standard perceived
value, it is likely to fail, sometimes companies
increase their price without any increase in
the value, it may work for a very short term
7. High price / low value : It combines high price
with low perceived value, it is only suitable in
monopoly market, adding value is not the
concern as the customers are ready to accept
the product at any price, it is also likely to fail
8. Low value /standard price: It combines the
high price with low perceived value, this
strategy decreases market share of the
company, hence, it is likely to fail
 Growth strategy
• Growth strategies are designed to achieve
growth in sales, assets, profits or some
combination.
• Organisation can grow internally by expanding
its operations or externally through merger,
acquisitions and strategic alliances
• It is suitable when the products are in the
growth stage of their life cycle
• Production and market share are increased
 Strategic alternatives under growth strategy
1. Concentration: it is a decision to concentrate
resources on certain product lines.
i. Vertical growth: it can be achieved by taking over a
function previously provided by a supplier or by a
distributor, it is done to reduce costs, gain control
over a scarce resource, guarantee quality of the key
input, obtain access to potential customers
ii. Horizontal growth: it can be achieved by expanding
the organisational operations into other geographic
locations and by increasing the range of products and
services offered to current markets, it is done
through internal development or externally through
acquisitions and strategic alliances with other firms in
the same industry
 2. Diversification
i. Related diversification: it is diversifying into an
industry related to the current one, it may be a
very appropriate strategy when a firm has a
strong competitive position but industry
attractiveness is low
ii. Unrelated diversification: it is diversifying into
an industry unrelated to its current one, it is
pursued if the current industry is unattractive
and lacks outstanding abilities or skills that is
could easily transfer to related products or
services in other industries
 Advantages of growth strategy
1. Increase market power
2. Suitable for highly competitive and dynamic
environment
3. Psychological satisfaction
4. Strategic advantage
5. Productivity and efficiency
Disadvantages of growth strategy
1. Lose the existing market share
2. Existing resources and capabilities may not
be enough
3. Risky
 Implementing growth strategies
1. Internal development
2. Mergers and acquisitions
3. Joint development and strategic alliances
 1. Internal development
• Strategies are developed by building the
organization's own capabilities.
• Internal strategic factors are developed for
strategic success.
• It is also known as organic development.
Ways of internal development
• Product development
• Market development
• Competence building through learning
• Cost spread
 It is appropriate for small companies or many
public services, highly technical productions.
To expand the market by using core
competency,
Helps to remove behavioral and cultural
problems.
 2. Mergers and acquisitions v v
• Merger is a strategy through which two firms
agree to integrate their operations on a relatively
coequal basis. It is the combination of two or
more organizations into one single organization.
Merger can be :
a) Horizontal merger: it is the merger between
firms in the same line of business, such as ,a
merger between two commercial banks.
b) Vertical merger: two firms producing
complementary products merge and form a new
firm, such as ,merger between leather
processing firm and shoe company.
c) Concentric merger: if two firms serving the
same customer group merge with each other,
it is called concentric merger, such as, merger
of two colleges.
d) Conglomerate merger: if two firms with
different products merge with each other, it
is known as conglomerate merger, such as,
merger between school and hotel.
 Acquisition
• An acquisition is a strategy in which one firm
buys another firm. An existing organization
takes over another organization through
purchase of shares or ownership. The
acquired organization keeps its separate
identity.
Reasons of acquisition and merger
a) Increased market power
b) Overcoming entry barriers
c) Increased speed to market
d) Low risks
e) Increased diversification
f) Reshaping competitive scope
g) Learning and developing new capabilities
 3. Joint development and strategic
alliance
• A company uses competitive strategies to gain
competitive advantage within an industry by
battling against other firms. Cooperative strategy
can also be used. The main aim of joint
development and strategic alliance is to build and
share competences for mutual benefits.
a) Collusion: it is the active cooperation of firms
within an industry to reduce output and raise
prices. It may be explicit, in which firms
cooperate through direct communication and
negotiation or tacit, in which firms cooperate
indirectly through an informal system of signals.
Explicit collusion is illegal in most countries.
b) Strategic alliance: it is a cooperative strategy
in which firms combine some of their
recourses and capabilities to create a
competitive advantage. It involves some
degree of exchange and sharing of resources
and capabilities to develop, sell and serve
goods or services.
 Reasons for strategic alliance
a. Resource utilization
b. Cost and value
c. Co-specialization
d. New markets access
e. Learning
f. Risk management
g. Competition
 Portfolio analysis
Portfolio means a range of investments held by
an organization. Portfolio analysis enables an
organization to revise and refresh the portfolio
by closing down the unprofitable business
units or products and adding new investment
in a profitable way. The aim of this analysis is
to achieve the highest overall return on
investment.
 Advantages of portfolio analysis
• It encourages top management to evaluate,
set objectives and allocate resources for each
business unit individually.
• It stimulates the use of externally oriented
data to supplement management’s judgment
and decisions.
• It raises the issue of cash-flow availability for
use in expansion and growth.
• Its graphic representation facilitates
communication .
 Tools of portfolio analysis
1. Boston Consulting Group (BCG) Matrix
2. The General Electric (GE) – McKinsey Matrix
 Boston Consulting Group ( BCG) Matrix v
• BCG Matrix is the simplest way to portray a
company’s portfolio of investment.
• It was developed by Boston Consulting Group
• In BCG matrix, each of the company’s product
lines or business units is plotted according to
the growth rate of the industry in which it
competes and its relative market share.
The four cells on BCG matrix are:
 1. Stars
• Stars are those business units which have rapidly
growing markets with large market share
• They represent the best long run opportunities i.e.
growth and profitability in the firm’s portfolio
• Able to generate enough cash, use large amounts of
cash to maintain their high share of the market, bright
future, best long run opportunities for growth and
profitability
• The strategies options for stars are: forward, backward
and horizontal integration; market penetration; market
development and product development
• When their market growth rate slows, stars become
cash cows.
 2. Cash cows
• Cash cows are those business units which have
high market share but low market growth rate.
• Cows were yesterday’s Stars, generate enough
cash needed to maintain their market share, they
have low costs relative to competitors, do not
require further investment because of stable
growth
• The strategies options are: Product development,
diversification, retrenchment and divestiture
• When they become weak, retrenchment
(reduction of expenditure) or divestiture (sell) can
become more appropriate strategies
 3. Dogs
• Dogs are the business units with low market
share and low growth rate.
• Need more cash to survive, pose very low
competitive position because of high costs,
low quality and low profit
• Have no future prospects
• This is usually a situation firms seek to avoid
• Retrenchment, liquidation and divestiture may
be suitable strategies
 4. Question marks
• Question marks sometimes called “problem children”
or “wildcats”
• They are the business units or products with the
potential for success, but need a lot of cash for
development.
• High market growth but low market share, require a
high investment for advertisement, product
reformulation and distribution
• Uncertain future so should develop or stop the
business
• Market penetration, market development, product
development and divestiture are the strategic options
 Limitations of BCG Matrix
• Difficult to assess the high and low growth rate
and market share
• It is applicable for strategic business units only
• There might be a number of variables affecting
the industry attractiveness besides market share
and growth rate
• The use of highs and lows to form four categories
is too simplistic
• The link between market share and profitability is
questionable. Low share businesses can also be
profitable
• Growth rate is only one aspect of industry
attractiveness
• Market share is only one aspect of overall
competitive position
• It is based on only one competitor as the
market leader. Small competitors with fast-
growing market share are ignored
The General Electric-McKinsey Matrix
• General Electric, with the assistance of the
McKinsey & Company consulting form
developed GE matrix.
• It includes nine cells based on long-term
industry attractiveness and business
strength/competitive position
 Green
• The strategic business units in Green cells are the
winners. They should be given priority in portfolio.
They get priority in investment.
• Companies should invest into the business units that
fall into these boxes as they promise the highest
returns in the future.
• These business units will require a lot of cash because
they’ll be operating in growing industries and will have
to maintain or grow their market share.
• It is essential to provide as much resources as possible
for BUs so there would be no constraints to grow.
• The investments should be provided for R&D,
advertising, acquisitions and to increase the production
capacity to meet the demand in the future.
 Yellow
• Yellow cells indicate the medium or average
situation of strategic business units. They should be
included in the portfolio on a selective basis for
investment.
• You should invest into these BUs only if you have the
money left over the investments in invest/grow
business units group and if you believe that BUs will
generate cash in the future.
• These business units are often considered last as
there’s a lot of uncertainty with them.
• The general rule should be to invest in business units
which operate in huge markets and there are not many
dominant players in the market, so the investments
would help to easily win larger market share.
 Red
• Red cells are the loser strategic business units.
They should be diverted or closed down.
• The business units that are operating in
unattractive industries don’t have sustainable
competitive advantages or are incapable of
achieving it and are performing relatively poorly
fall into harvest/divest boxes.
• The business units that only make losses should
be divested. If that’s impossible and there’s no
way to turn the losses into profits, the company
should liquidate the business unit.
 Limitations of GE Matrix
• It can get quite complicated and cumbersome
• Subjective judgments that may vary from one
person to another
• It cannot effectively represent the positions of
new products or business units in developing
industries
• It provides only broad strategic prescriptions
rather than specifics
 Strategy evaluation
1. Suitability
a. Ranking
b. Decision Tree
c. Scenario Planning
2. Acceptability
a. Analysis of Return
b. Analysis of Stakeholders’ Reaction
c. Analysis of Risk
3. Feasibility
a. Funds Flow Statement
b. Break-even Analysis
c. Resource Deployment Analysis
 1. Suitability
• Suitability requires a broad assessment of the
extent to which new strategies would fit with the
future trend and change in the environment,
exploit the strategic capability of an organisation
and meet the expectation of the stakeholders.
a. Ranking: ranking compares strategic options
against the key strategic elements from the SWOT
analysis. A rank is by the environment, resources,
expectations and a score is established for each
option.
 a. Ranking
Strategic Key Strategic Factors
stakehold Investme Cost Marketing technolog Producer ranking
er nt reduction y quality

1. Do nothing ? ? ? ? X X C
2. Expand ? ? ? ? ? ? B
3. Growth ? X X ? X ? B
4. √ ? √ ? ? ? A
Diversification

5. Merger X X ? ? ? ? C
6. Alliance ? ? X ? ? ? C

√ = Favourable A = Most suitable

X = Unfavourable B = Possible
? = Uncertain C = Unsuitable

In the above table, diversification is the most suitable strategic option.

 b. Decision Tree
• Options are eliminated by progressively
introducing further requirements to be met in
decision tree.
• Preferred options emerge by eliminating other
undesired options.
 b. Decision Tree
Growth Investment Diversification Strategic Options

Yes 1. Acquisition

High No 2. Penetration
3. Strategic alliance
Yes
Growth Low
Current 4. Consolidation
Business No
Yes 5. Move to new markets
No growth High No
6. Invest in IT
Low Yes 7. Retrain alliance partners

No 8. No change
 c. Scenario planning
• Scenario planning match strategic options to different
possible future scenarios.
• This is useful if a high degree of uncertainty exists.
• It is a contingency plan which identifies the preferred
options for each possible future scenario.
• Steps of scenario planning: identify critical factors in
the environment, identify the future trends of the
environmental factors, analyses reasons for past
behaviour for each trend, forecast three alternative
scenarios for each critical indicator/least favourable/
likely / most favourable, develop various scenarios
from the characteristics of factors.
 C. Scenario planning
Strategic Option Why this option might be suitable in term of:
Directions Environment Resources/ Expectations
competences
Consolidation Withdraw from Build on strengths Better returns at
declining markets through continued low risk by
(sales valuable investment and exploiting current
assets speculation) innovation strategies
Maintain market
share
Market penetration Gain market share Exploit superior
for advantage resources and
competences
Product Exploit knowledge Exploit R&D Better returns at
development of customer needs medium risk by
Market Current markets Exploit current exploiting current
development saturated, New products strengths or market
opportunities for knowledge
geographical
spread, entering
new segments or
new uses
 C. Scenario planning (Cont.)
Methods
Internal First in field Learning and Cultural/ political
development Partners or competence ease
acquisitions not development/
‘available’ Spread of cost
Merger/ Acquisition Speed supply Acquire Returns: growth or
Demand P/E ratios competences scale share value
economies problems of culture
clash
Joint development Speed Complementary ‘Required ’ for entry
Industry norm competences Dilutes risk
Learning from Fashionable
partners
 2. Acceptability
• Acceptability is concerned with the expected
performance outcome.
• The acceptability test should address these problems:
– The changes in liquidity
– The appropriateness of any proposed change to general
expectations within the organisation
– The change in the function of any department, group or
individual
– The change in the organisation’s relationship with outside
stakeholders
– The acceptability of the strategy within the organisation’s
environment
– The financial performance of the company in terms
profitability
– The effect of capital structure
 a. Analysis of return
• Returns are the benefits that the stakeholders expect
to get from a particular strategy
• They may be financial and non-financial
• Different approaches of analysis of return
1. Profitability analysis
a. Return on capital employed: examines the
relationship between net profit after tax and capital
employed.
Return on capital employed= net profit after
tax/capital employed
b. Payback period: it measure the numbers of years
required for cash flow after tax to pay the original
investment back
payback period= investment/annual average cash
inflow
c. Discounted cash flows: techniques consider time
value of money
2. Cost-benefit analysis: attempts to put a money
value on all the costs and benefits of the
strategic option including intangibles
3. Shareholders’ value analysis: pays attention to
the primary legal responsibility of a company the
creation of shareholders’ value
Total shareholder return= increase in share price
during year + dividend earned during year/ share
price at the beginning of the year
 b. Analysis of Stakeholders’ Reaction
• Stakeholders are the individuals or groups around the
organisation who have stake in the outcomes of the
organisation.
• It is necessary to analyse and understand the
expectation of different stakeholders in order to
evaluate the strategic options
• Selecting a new strategy for implementation may
require issuing a large numbers of equity shareholders
• Selecting a new strategy to merge the firm with
another firm may be unacceptable for unions or some
customers
• Using an e-commerce business model might cut down
some distribution channels and may cause a risk of
backlash from the distributors
• A strategy to increase the market share might disturb
the market position
 C. Analysis of Risk
• Risk is concerned to the probability and
consequences of the failure of a strategy
• The risk is comparatively high with the
organisations involved in long term innovation
• Risk can be seen as both opportunity and
threat
• It should be assessed with proper
understanding of the company’s strategic
position (the environment, resources and
capabilities)
 Approaches of Analysis of Risk
1. Financial ratios: liquidity ratios, profitability
ratios, activity ratios, leverage ratios and other
ratios
2. Sensitivity analysis: useful technique to assess
the extent to which the success of a given
strategy depends on the key assumptions
underlying it e.g. 5% increase in profit/sales
3. Simulation modeling: analyzing risk factors in
selecting any strategic option
4. Heuristic models: the rules that guide decision
makers in searching alternatives with a high
probability of getting satisfactory results
 3. Feasibility
Feasibility is concerned with availability of resource and
competencies to deliver a strategic option. It examines
whether the strategic option can be implemented
successfully or not.
a. Funds Flow Statement: it estimates the funds required
and the likely sources of those funds for a strategic
option. It seeks to identify the fund that is required to
achieve a strategy. It demonstrates inflows and outflow
of cash and cash equivalents.
b. Break-even Analysis: it assesses relationships among
cost, volume and profit. It identifies breakeven point
where revenue equals to costs. Profit is possible when
sales exceed the breakeven point.
c. Resource Deployment Analysis: it assesses the
resources and competencies required for a particular
strategy. The strategist can monitor the underlying
resources and competencies for each strategy.