Chapter 6
Diversification: Strategies for Managing a Group of Businesses

Core Concepts

• Creating added value for shareholders via diversification requires building a multibusiness company where the whole is greater than the some of its parts.
• The biggest drawback to entering an industry by forming a start-up company internally are the costs of overcoming entry barriers and the extra time it takes to build a strong and profitable competitive position.
• Related businesses possess competitively valuable cross-business value chain match ups; unrelated businesses have very dissimilar value chains, containing no competitively useful cross-business relationships.
• Strategic fit exists when the value chains of different businesses present opportunities for cross-business resource transfer, lower costs through combining the performance of related value chain activities, cross-business use of a potent brand name, and cross-business collaboration to build new or stronger competitive capabilities.
• Economies of scope are cost reductions that flow from operating in multiple businesses; such economies stem directly from strategic fit efficiencies along the value chains of related businesses.
• Diversifying into related businesses where competitively valuable strategic-fit benefits can be captured puts sister businesses in position to perform better financially as part of the same company than they could have performed as independent enterprises, thus providing a clear avenue for boosting shareholder.
• The two biggest drawbacks to unrelated diversification are the difficulties of competently managing many different businesses and being without the added sources of competitive advantage that cross-business strategic fit provides.
• Relying solely on the expertise of corporate executives to wisely manage a set of unrelated businesses is a much weaker foundation for enhancing shareholder value than is a strategy of related diversification where corporate performance can be boosted by the capture of competitively valuable strategic fits, as well as by wise and expert corporate level management.
• A company's businesses exhibit resource fit when the various businesses, individually and collectively, add to the company's complement of resources is adequate to support the requirements of its business units.
• A cash hog is a business whose internal cash flows are inadequate to fully fund its needs for working capital and new capital investment. A cash cow business is one which generates cash flows over and above its internal requirements, thus providing a corporate parent with funds for investing in cash hog businesses, financing new acquisitions, or paying dividends.
• Focusing corporate resources on a few core and mostly related businesses avoids the mistake of diversifying so broadly that resources and management attention are stretched too thinly.
• Restructuring involves divesting some businesses and acquiring others so as to put a whole new face on the company's business lineup.
• A strategy of multinational diversification has more built-in potential for competitive advantage than any other diversification strategy.
   

Key Points

Most companies have their business roots in a single industry. Even though they may have since diversified into other industries, a substantial part of their revenues and profits still usually comes from the original or core business. Diversification becomes an attractive strategy when a company runs out of profitable growth opportunities in its original business. The purpose of diversification is to build shareholder value.

Diversification builds shareholder value when a diversified group of businesses can perform better under the auspices of a single corporate parent than they would as independent, stand-alone businesses—the goal is to achieve not just a 1 _ 1 _ 2 result but to realize important 1 _ 1 _ 3 performance benefits. Whether getting into a new business has potential to enhance shareholder value hinges on whether a company's entry into that business can pass the attractiveness test, the cost-of-entry test, and the better-off test.

Entry into new businesses can take any of three forms: acquisition, internal startup, or joint venture or strategic partnership. Each has its pros and cons, but acquisition is the most frequently used; internal start-up takes the longest to produce home-run results, and joint venture or strategic partnership, though used second most frequently, is the least durable.

There are two fundamental approaches to diversification—into related businesses and into unrelated businesses. The rationale for related diversification is strategic: diversify into businesses with strategic fits along their respective value chains, capitalize on strategic-fit relationships to gain competitive advantage, and then use competitive advantage to achieve the desired 1 _ 1 _ 3 impact on shareholder value. Businesses have strategic fit when their value chains offer potential (1) for realizing economies of scope or cost-saving efficiencies associated with sharing technology, facilities, functional activities, distribution outlets, or brand names; (2) for facilitating competitively valuable cross-business transfers of technology, skills, know-how, or other resource capabilities; (3) for leveraging use of a well-known and trusted brand name; and (4) for engaging in competitively valuable cross-business collaboration to build new or stronger resource strengths and competitive capabilities.

The basic premise of unrelated diversification is that any business that has good profit prospects and can be acquired on good financial terms is a good business to diversify into. Unrelated diversification strategies surrender the competitive advantage potential of strategic fit in return for such advantages as (1) spreading business risk over a variety of industries and (2) providing opportunities for financial gain (if candidate acquisitions have undervalued assets, are bargain-priced and have good upside potential given the right management, or need the backing of a financially strong parent to capitalize on attractive opportunities). In theory, unrelated diversification also offers greater earnings stability over the business cycle (a third advantage), but this advantage is very hard to realize in actual practice. The greater the number of businesses a conglomerate is in and the more diverse these businesses are, the harder it is for corporate executives to select capable managers to run each business, know when the major strategic proposals of business units are sound, or decide on a wise course of recovery when a business unit stumbles. Unless corporate managers are exceptionally shrewd and talented, unrelated diversification is a dubious and unreliable approach to building shareholder value when compared to related diversification. Analyzing how good a company's diversification strategy involves a six-step process:

Step 1: Evaluate the long-term attractiveness of the industries into which the firm has diversified. Industry attractiveness needs to be evaluated from three angles: the attractiveness of each industry on its own, the attractiveness of each industry relative to the others, and the attractiveness of all the industries as a group. Quantitative measures of industry attractiveness tell a valuable story about how and why some of the industries a company has diversified into are more attractive than others. The two hardest parts of calculating industry attractiveness scores are deciding on appropriate weights for the industry attractiveness measures and knowing enough about each industry to assign accurate and objective ratings.

Step 2: Evaluate the relative competitive strength of each of the company's business units. Again, quantitative ratings of competitive strength are preferable to subjective judgments. The purpose of rating the competitive strength of each business is to gain clear understanding of which businesses are strong contenders in their industries, which are weak contenders, and the underlying reasons for their strength or weakness. The conclusions about industry attractiveness can be joined with the conclusions about competitive strength by drawing an industry attractiveness-competitive strength matrix displaying the positions of each business on a nine-cell grid. The attractiveness-strength matrix helps identify the prospects of each business and what priority each business should be given in allocating corporate resources and investment capital.

Step 3: Check for cross-business strategic fits.A business is more attractive strategically when it has value chain relationships with sister business units that present opportunities to transfer skills or technology, reduce overall costs, share facilities, or share a common brand name—any of which can represent a significant avenue for producing competitive advantage beyond what any one business can achieve on its own. The more businesses with competitively valuable strategic fits, the greater a diversified company's potential for achieving economies of scope, enhancing the competitive capabilities of particular business units, and/or strengthening the competitiveness of its product and business lineup, thereby realizing a combined performance greater than the units could achieve operating independently.

Step 4: Check whether the firm's resource strengths fit the resource requirements of its present business lineup. Resource fit exists when (1) businesses add to a company's resource strengths, either financially or strategically; (2) a company has the resources to adequately support the resource requirements of its businesses as a group without spreading itself too thin; and (3) there are close matches between a company's resources and industry key success factors. One important test of resource fit concerns whether the company's business lineup is well matched to its financial resources. Assessing the cash requirements of different businesses in a diversified company's portfolio and determining which are cash hogs and which are cash cows highlights opportunities for shifting corporate financial resources between business subsidiaries to optimize the performance of the whole corporate portfolio, explains why priorities for corporate resource allocation can differ from business to business, and provides good rationalizations for both invest-and expand strategies and divestiture.

Step 5: Rank the performance prospects of the businesses from best to worst and determine what the corporate parent's priority should be in allocating resources to its various businesses. The most important considerations in judging business-unit performance are sales growth, profit growth, contribution to company earnings, and the return on capital invested in the business. Sometimes, cash flow generation is a big consideration. Normally, strong business units in attractive industries have significantly better performance prospects than weak businesses or businesses in unattractive industries. Information on each business's past performance can be gleaned from a company's financial records. While past performance is not necessarily a good predictor of future performance, it does signal which businesses have been strong performers and which have been weak performers. The industry attractiveness-competitive strength evaluations provide a basis for judging future prospects. Normally, strong business units in attractive industries have significantly better prospects than weak businesses in unattractive industries. And, normally, the revenue and earnings outlook for businesses in fast-growing industries is better than for businesses in slow-growing industries. The rankings of future performance generally determine what a business unit's priority for resource allocation by the corporate parent should be. Business subsidiaries with the brightest profit and growth prospects and solid strategic and resource fits generally should head the list for corporate resource support.

Step 6: Craft new strategic moves to improve overall corporate performance. This step entails using the results of the preceding analysis as the basis for devising actions to strengthen existing businesses, make new acquisitions, divest weak-performing and unattractive businesses, restructure the company's business lineup, expand the scope of the company's geographic reach multinationally or globally, and otherwise steer corporate resources into the areas of greatest opportunity. Once a company has diversified, corporate management's task is to manage the collection of businesses for maximum long-term performance. There are four different strategic paths for improving a diversified company's performance: (1) broadening the firm's business base by diversifying into additional businesses, (2) retrenching to a narrower diversification base by divesting some of its present businesses, (3) corporate restructuring, and (4) multinational diversification.

Broadening the diversification base is attractive when growth is sluggish and the company needs the revenue and profit boost of a newly acquired business, when it has resources and capabilities that are eminently transferable to related or complementary businesses, or when the opportunity to acquire an attractive company unexpectedly lands on its doorstep. Furthermore, there are occasions when a diversified company makes new acquisitions to complement and strengthen the market position and competitive capabilities of one or more of its present businesses.

Retrenching to a narrower diversification base is usually undertaken when corporate management concludes that the firm's diversification efforts have ranged too far a field and that the best avenue for improving long-term performance is to concentrate on building strong positions in a smaller number of businesses. Retrenchment is usually accomplished by divesting businesses that are no longer deemed suitable for the company to be in. A business can become a prime candidate for divestiture because market conditions in a once attractive industry have badly deteriorated, because it lacks adequate strategic or resource fit, because it is a cash hog with questionable long-term potential, or because it is weakly positioned in its industry with little prospect for earning a decent return on investment. Sometimes a company acquires businesses that just do not work out as expected even though management has tried all it can think of to make them profitable. Divesting such businesses frees resources that can be used to reduce debt, to support expansion of the remaining businesses, or to make acquisitions that materially strengthen the company's competitive position in one or more of the remaining core businesses. Most of the time, companies divest businesses by selling them to another company, but sometimes they spin them off as financially and managerially independent enterprises in which the parent company may or may not retain an ownership interest.

Corporate restructuring strategies involve divesting some businesses and acquiring new businesses so as to put a whole new face on the company's business makeup. Performing radical surgery on the group of businesses a company is in becomes an appealing strategy alternative when a diversified company's financial performance is being squeezed or eroded by (1) too many businesses in slow-growth or declining or low-margin or otherwise unattractive industries, (2) too many competitively weak businesses, (3) ongoing declines in the market shares of one or more major business units that are falling prey to more market-savvy competitors, (4) an excessive debt burden with interest costs that eat deeply into profitability, or (5) ill-chosen acquisitions that haven't lived up to expectations.

Multinational diversification strategies feature a diversity of businesses and a diversity of national markets. Despite the complexity of having to devise and manage so many strategies (at least one for each industry, with as many variations for country markets as may be needed), multinational diversification strategies have considerable appeal. They offer two avenues for long-term growth in revenues and profitability— one is to grow by entering additional businesses, and the other is to grow by extending the operations of existing businesses into additional country markets. Moreover, multinational diversification offers six ways to build competitive advantage: (1) full capture of economies of scale and experience- or learning-curve effects, (2) opportunities to capitalize on cross-business economies of scope, (3) opportunity to transfer competitively valuable resources from one business to another and from one country to another, (4) ability to leverage use of a well-known and competitively powerful brand name, (5) ability to capitalize on opportunities for cross-business and cross-country collaboration and strategic coordination, and (6) opportunities to use cross-business or cross-country subsidization to wrest sales and market share from rivals. A strategy of multinational diversification contains more competitive advantage potential than any other diversification strategy.

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Chapter 7
Strategy, Ethics, and Social Responsibility

Core Concepts

• Business ethics concerns the application of general ethical principles and standards to the actions and decisions of companies and the conduct of company personnel.
• According to the school of ethical universalism, the same standards of what's ethical and what's unethical resonate with peoples of most societies regardless of local traditions and norms; hence, common ethical standards can be used to judge the conduct of personnel at companies operating in a variety of country markets and cultural circumstances.
• According to the school of ethical relativism different societal cultures and customs have divergent values and standards of right and wrong—thus what is ethical or unethical must be judged in the light of local customs and social mores and can vary from one culture or nation to another.
• Varying ethical norms across countries and conflicting interpretations of what exactly constitutes honest, respect for human rights, respect for the environment, and so on, indicate that there are few absolutes when it comes to business ethics and thus few ethical absolutes for consistently judging a company's conduct in various countries and markets.
• According to the school of ethical relativism different societal cultures and customs have divergent values and standards of right and wrong— thus what is ethical or unethical must be judged in the light of local customs and social mores and can vary from one culture or nation to another.
• Varying ethical norms across countries and conflicting interpretations of what exactly constitutes honesty, respect for human rights, respect for the environment, and so on, indicate that there are few absolutes when it comes to business ethics and thus few ethical absolutes for consistently judging a company's conduct in various countries and markets.
• Amoral manages believe that businesses ought to be able to do whatever current laws and regulations allow them to do without being shackled by ethical considerations —they think that what is permissible and what is not is governed entirely by prevailing laws and regulations, not by societal concepts of right and wrong.
• The main objective of the damage control approach is to protect against adverse publicity and any damaging consequences brought on by headlines in the media, outside investigation, threats of litigation, punitive government action, or angry or vocal stakeholders.
• Conducting business in an ethical fashion is in a company's enlightened self-interest.
• More attention is paid to linking strategy with ethical principles and core values in companies headed by moral executives and in companies where ethical principles and core values are a way of life.
• The notion of social responsibility as it applies to businesses concerns a company's duty to operate by means that avoid harm to stakeholders and the environment and further, to consider the overall betterment of society in its decisions and actions.
• Business leaders who want their companies to be regarded as exemplary corporate citizens must not only see that their companies operate ethically, but also display a social conscience in decisions that affect employees, the environment, the communities in which they operate, and society at large.
• A company's social responsibility strategy is defined by the specific combination of socially beneficial activities it opts to support with its contributions of time, money, and other resources.
• Many companies tailor their strategic efforts to operate in a socially responsible manner to fit their core values and business mission, thereby making their own statement about "how we do business and how we intend to fulfill our duties to all stakeholders and society at large."
• Every action a company takes can be interpreted as a statement of what the company stands for.
• The higher the public profile of a company or brand, the greater scrutiny of its activities and the higher the potential for it to become a target for pressure group action.
• There is little hard evidence indicating shareholders are disadvantaged in any meaningful or substantive way by a company's actions to be socially responsible.
   
   

Key Points

Ethics involves concepts of right and wrong, fair and unfair, moral and immoral. Beliefs about what is ethical serve as a moral compass in guiding the actions and behaviors of individuals and organizations. Ethical principles in business are not materially different from ethical principles in general.

There are three schools of thought about ethical standards:

• According to the school of ethical universalism, the same standards of what's ethical and what's unethical resonate with peoples of most societies regardless of local traditions and cultural norms; hence, common ethical standards can be used to judge the conduct of personnel at companies operating in a variety of country markets and cultural circumstances.
• According to the school of ethical relativism, different societal cultures and customs have divergent values and standards of right and wrong—thus what is ethical or unethical must be judged in the light of local customs and social mores and can vary from one culture or nation to another.
• According to integrated social contracts theory, universal ethical principles or norms based on the collective views of multiple cultures and societies combine to form a "social contract" that all individuals in all situations have a duty to observe. Within the boundaries of this social contract, local cultures can specify other impermissible actions; however, universal ethical norms always take precedence over local ethical norms.

A company has to be very cautious about exporting its home-country values and ethics to foreign countries where it operates—"photocopying" ethics is disrespectful of other countries' values and traditions. However, there are occasions when the rule of "when in Rome, do as the Romans do" is ethically and morally wrong irrespective of local customs, traditions and norms—one such case is the payment of bribes and kickbacks. Managers in multinational enterprises have to figure out how to navigate the gray zone that arises when operating in two cultures with two sets of ethics. Three categories of managers stand out in terms of their prevailing beliefs in and commitments to ethical and moral principles in business affairs: the moral manager, the immoral manager, and the amoral manager. By some accounts, the population of managers is said to be distributed among all three types in a bell-shaped curve, with immoral managers and moral managers occupying the two tails of the curve and the amoral managers, especially the intentionally amoral managers, occupying the broad middle ground. The apparently large numbers of immoral and amoral businesspeople are one obvious reason why some companies resort to unethical strategic behavior. Three other main drivers of unethical business behavior also stand out:

• Overzealous or obsessive pursuit of personal gain, wealth, and other selfish interests.
• Heavy pressures on company managers to meet or beat earnings targets.
• A company culture that puts profitability and good business performance ahead of ethical behavior.

The stance a company takes in dealing with or managing ethical conduct at any given time can take any of four basic forms:

• The unconcerned or non-issue approach.
• The damage control approach.
• The compliance approach.
• The ethical culture approach.

The challenges that arise in each of the four approaches provide an explanation of why a company's executives may sense that they have exhausted a particular mode's potential for managing ethics and need to move to a stronger, more forceful approach to ethics management.

There are two reasons why a company's strategy should be ethical: (1) because a strategy that is unethical in whole or in part is morally wrong and reflects badly on the character of the company personnel involved and (2) because an ethical strategy is good business and in the self-interest of shareholders.

The term corporate social responsibility concerns a company's duty to operate in an honorable manner, provide good working conditions for employees, be a good steward of the environment, and actively work to better the quality of life in the local communities where it operates and in society at large. The menu of actions and behavior for demonstrating social responsibility includes:

• Employing an ethical strategy and observing ethical principles in operating the business.
• Making charitable contributions, donating money and the time of company personnel to community service endeavors, supporting various worthy organizational causes, and making a difference in the lives of the disadvantaged. Corporate commitments are further reinforced by encouraging employees to support charitable and community activities.
• Protecting or enhancing the environment and, in particular, striving to minimize or eliminate any adverse impact on the environment stemming from the company's own business activities.
• Creating a work environment that makes the company a great place to work.
• Employing a workforce that is diverse with respect to gender, race, national origin, and perhaps other aspects that different people bring to the workplace.

There's ample room for every company to tailor its social responsibility strategy to fit its core values and business mission, thereby making its own statement about "how we do business and how we intend to fulfill our duties to all stakeholders and society at large." The moral case for social responsibility boils down to a simple concept: it's the right thing to do. The business case for social responsibility holds that it is in the enlightened self-interest of companies to be good citizens and devote some of their energies and resources to the betterment of such stakeholders as employees, the communities in which they operate, and society in general. There are three reasons why the exercise of social responsibility is good business:

• It generates internal benefits (particularly as concerns employee recruiting, workforce retention, and training costs).
• It reduces the risk of reputation-damaging incidents and can lead to increased buyer patronage. The higher the public profile of a company or brand, the greater the scrutiny of its activities and the higher the potential for it to become a target for pressure-group action.
• It is in the best interest of shareholders.

Companies that take social responsibility seriously can improve their business reputations and operational efficiency while also reducing their risk exposure and encouraging loyalty and innovation. Overall, they are more likely to be seen as good investments and as good companies to work for or do business with.

However, there is a school of thought that says companies should be very cautious in their endeavors to better the overall well-being of society because doing so diverts valuable resources and weakens a company's competitiveness. According to this view, businesses best satisfy their social responsibilities through conventional business activities— producing needed goods and services at prices consistent with the lowest feasible costs. They further argue that spending shareholders' or customers' money for social causes not only muddies decision making by diluting the focus on the company's business mission but also thrusts business executives into the role of social engineers—a role more appropriately performed by charitable and nonprofit organizations and duly-elected government officials. Yet it is tough to argue that businesses have no obligations to non-owner stakeholders or to society at large. If one looks at the category of activities that fall under the umbrella of socially responsible behavior (refer to Figure 7.2), there's really very little to object to in principle. The main problems come in judging the specifics of how well a company goes about the particular social betterment and corporate citizenship activities that it opts to pursue. Are the actions self-serving? Do the actions go far enough? Were the actions done in an appropriate fashion?

In sum, the case for ethical and socially responsible behavior is about attracting and retaining talented staff, about managing risk, and about ensuring a company's reputation with customers, suppliers, local communities, and society.

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Part IV Executing the Strategy

Chapter 8
Executing a Strategy, Building a Capable Organization and Instilling a Culture

Core Concepts
 

• Implementing and executing a company's strategy is a job for the entire management team, not just a few senior mangers.
• When strategies fail, it is often because of poor execution &8212; things that were supposed to get done slip through the cracks.
• Putting together a talented management team with the right mix of skills and experiences is one of the first strategy implementing steps.
• In many industries adding to a company's talent base and building intellectual capital is more important to good strategy execution than additional investments in capital projects.
• Building competencies and capabilities is a multi-stage process that occurs over a period of months and years, not something that can be done overnight.
• Competencies and capabilities has a huge payoff — improved strategy execution and a potential for competitive advantage.
• Wisely choosing which activities to perform internally and which to outsource can lead to several strategy-executing advantages — lower costs, heightened strategic focus, less internal bureaucracy, speedier decision making, and a better arsenal of competencies and capabilities.
• There are serious disadvantages to having a small number of top-level managers micro manage the business by personally making decisions or by requiring they approve the recommendations of lower-level subordinates before actions can be taken.
• The ultimate goal of decentralized decision-making is to put decisions to lower levels but to put decision-making authority in the hands of those persons or teams closest to and most knowledgeable about the situations.
• Corporate culture refers to the character of a company's internal work climate and "personality" — as shaped by its core values, beliefs, business principles, traditions, ingrained behaviors, and style of operating.
• Because culturally approved behavior thrives and culturally disapproved behavior gets squashed, company managers are well advised to spend time creating a culture that supports and encourages the behaviors conducive to good strategy.
• In a strong culture company, values and behavioral norms are like crabgrass; deeply rooted and hard to weed out.
• In adaptive cultures, there is a spirit of doing what is necessary to ensure long-term organizational success provided the new behaviors and operating practices that management is calling for are seen as legitimate and consistent with the core values and business principles underpinning the culture.
• A good case can be made that a strongly planted, adaptive culture is the best of all corporate cultures.
• Once a culture is established, it is difficult to change.
• A company's values statements and code of ethics communicate expectations of how employees should conduct themselves in the workplace.
   

Key Points

The job of strategy implementation and execution is to convert strategic plans into actions and good results. The test of successful strategy execution is whether actual organization performance matches or exceeds the targets spelled out in the strategic plan. Shortfalls in performance signal weak strategy, weak execution, or both. In deciding how to implement a new or revised strategy, managers have to determine what internal conditions are needed to execute the strategic plan successfully. Then they must create these conditions as rapidly as practical. The process of implementing and executing strategy involves:

1. Building an organization with the competencies, capabilities, and resource strengths to execute strategy successfully.
2. Allocating ample resources to strategy-critical activities.
3. Ensuring that policies and procedures facilitate rather than impede strategy execution.
4. Instituting best practices and pushing for continuous improvement in how value chain activities are performed.
5. Installing information and operating systems that enable company personnel to carry out their strategic roles proficiently.
6. Tying rewards and incentives directly to the achievement of strategic and financial targets and to good strategy execution.
7. Shaping the work environment and corporate culture to fit the strategy.
8. Exerting the internal leadership needed to drive implementation forward and to keep improving on how the strategy is being executed.

In implementing and executing a new or different strategy, managers should start with a probing assessment of what the organization must do differently and better to carry out the strategy successfully. They should then consider precisely how to make the necessary internal changes as rapidly as possible.

Like crafting strategy, executing strategy is a job for a company's whole management team, not just a few senior managers. Top-level managers have to rely on the active support and cooperation of middle and lower managers to push strategy changes into functional areas and operating units and to see that the organization actually operates in accordance with the strategy on a daily basis.

Building a capable organization is always a top priority in strategy execution; three types of organization-building actions are paramount: (1) staffing the organization— putting together a strong management team and recruiting and retaining employees with the needed experience, technical skills, and intellectual capital, (2) building core competencies and competitive capabilities that will enable good strategy execution and updating them as strategy and external conditions change, and (3) structuring the organization and work effort—organizing value chain activities and business processes and deciding how much decision-making authority to push down to lower-level managers and frontline employees.

Selecting able people for key positions tends to be one of the earliest strategy implementation steps. No company can hope to perform the activities required for successful strategy execution without attracting capable managers and without recruiting and retaining employees who give it a suitable knowledge base and portfolio of intellectual capital.

Building core competencies and competitive capabilities is a time-consuming, managerially challenging exercise that involves three stages: (1) developing the ability to do something, however imperfectly or inefficiently, by selecting people with the requisite skills and experience, upgrading or expanding individual abilities as needed, and then molding the efforts and work products of individuals into a collaborative group effort; (2) coordinating group efforts to learn how to perform the activity consistently well and at an acceptable cost, thereby transforming the ability into a tried-and- true competence or capability; and (3) continuing to polish and refine the organization's know-how and otherwise sharpen performance such that the company becomes better than rivals at performing the activity, thus raising the core competence (or capability) to the rank of a distinctive competence (or competitively superior capability) and opening an avenue to competitive advantage. Many companies manage to get through stages 1 and 2 in performing a strategy-critical activity but comparatively few achieve sufficient proficiency in performing strategy-critical activities to qualify for the third stage.

Strong core competencies and competitive capabilities are an important avenue for securing a competitive edge over rivals in situations where it is relatively easy for rivals to copy smart strategies. Any time rivals can readily duplicate successful strategy features, making it difficult or impossible to beat them in the marketplace with a superior strategy, the chief way to achieve lasting competitive advantage is to beat them by performing certain value chain activities in superior fashion. Building core competencies, resource strengths, and organizational capabilities that rivals can't match is one of the best and most reliable ways to achieve a competitive edge based on operating excellence.

Structuring the organization and organizing the work effort in a strategy-supportive fashion has five aspects: (1) deciding which value chain activities to perform internally and which ones to outsource; (2) making internally performed strategy-critical activities the main building blocks in the organization structure; (3) deciding how much authority to centralize at the top and how much to delegate to down-the-line managers and employees; (4) providing for internal cross-unit coordination and collaboration to build and strengthen internal competencies/capabilities; and (5) providing for the necessary collaboration and coordination with suppliers and strategic allies. Building an organization capable of proficient strategy execution entails a process of consciously knitting together the efforts of individuals and groups. Competencies and capabilities emerge from establishing and nurturing cooperative working relationships among people and groups to perform activities in a more customer-satisfying fashion, not from rearranging boxes on an organization chart.

A company's culture is manifested in the values and business principles that management preaches and practices, in the tone and philosophy of official policies and procedures, in its revered traditions and oft-repeated stories, in the attitudes and behaviors of employees, in the peer pressures that exist to display core values, in the organization's politics, in its approaches to people management and problem solving, in its relationships with external stakeholders (particularly vendors and the communities in which it operates), and in the atmosphere that permeates its work environment. Culture thus concerns the personality a company has and the style in which it does things. Very often, the elements of company culture originate with a founder or other early influential leaders who articulate the values, beliefs, and principles to which the company should adhere. These elements then get incorporated into company policies, a creed or values statement, strategies, and operating practices. Over time, these values and practices become shared by company employees and managers. Cultures are perpetuated as new leaders act to reinforce them, as new employees are encouraged to adopt and follow them, as stories of people and events illustrating core values and practices are told and retold, and as organization members are honored and rewarded for displaying cultural norms.

Company cultures vary widely in strength and in makeup. Some cultures are strongly embedded, while others are weak or fragmented. Some cultures are unhealthy, often dominated by self-serving politics, resistance to change, and inward focus. Unhealthy cultural traits are often precursors to declining company performance. In adaptive cultures, the work climate is receptive to new ideas, experimentation, innovation, new strategies, and new operating practices provided the new behaviors and operating practices that management is calling for are seen as legitimate and consistent with the core values and business principles underpinning the culture. An adaptive culture is a terrific managerial ally, especially in fast-changing business environments, because company personnel are receptive to risk taking, experimentation, innovation, and changing strategies and practices—there's a feeling of confidence that the organization can deal with whatever threats and opportunities come down the pike. In direct contrast to change-resistant cultures, adaptive cultures are very supportive of managers and employees at all ranks who propose or help initiate useful change; indeed, there's a proactive approach to identifying issues, evaluating the implications and options, and implementing workable solutions.

A culture grounded in values, practices, and behavioral norms that match what is needed for good strategy execution helps energize people throughout the company to do their jobs in a strategy-supportive manner, adding significantly to the power of a company's strategy execution effort and the chances of achieving the targeted results. But when the culture is in conflict with some aspect of the company's direction, performance targets, or strategy, the culture becomes a stumbling block. Thus, an important part of managing the strategy execution process is establishing and nurturing a good fit between culture and strategy.

Changing a company's culture, especially a strong one with traits that don't fit a new strategy's requirements, is one of the toughest management challenges. Changing a culture requires competent leadership at the top. It requires symbolic actions and substantive actions that unmistakably indicate serious commitment on the part of top management.

The more that culture-driven actions and behaviors fit what's needed for good strategy execution, the less managers have to depend on policies, rules, procedures, and supervision to enforce what people should and should not do. Healthy corporate cultures are grounded in ethical business principles, socially approved values, and socially responsible decision making. One has to be cautious in jumping to the conclusion that a company's stated values and ethical principles are mere window dressing. While some companies display low ethical standards, many companies are truly committed to the stated core values and to high ethical standards, and they make ethical behavior a fundamental component of their corporate culture. If management practices what it preaches, a company's core values and ethical standards nurture the corporate culture in three highly positive ways: (1) They communicate the company's good intentions and validate the integrity and above-board character of its business principles and operating methods, (2) they steer company personnel toward both doing the right thing and doing things right, and (3) they establish a corporate conscience that gauges the appropriateness of particular actions, decisions, and policies. Companies that really care about how they conduct their business put a stake in the ground, making it unequivocally clear that company personnel are expected to live up to the company's values and ethical standards—how well individuals display core values and adhere to ethical standards is often part of the job performance evaluations. Peer pressures to conform to cultural norms are quite strong, acting as an important deterrent to outside-the-lines behavior.

To be effective, corporate ethics and values programs have to become a way of life through training, strict compliance and enforcement procedures, and reiterated management endorsements. Moreover, top managers must practice what they preach, serving as role models for ethical behavior, values-driven decision making, and a social conscience.

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Chapter 9
Managing Internal Operations in Ways That Promote Good Strategy Execution

Core Concepts

• The funding requirements of a new strategy must drive how capital allocations are made and the size of each unit's operating budgets. Under funding organizational units and activities pivotal to strategic success impedes execution and the drive for operating excellence.
• Well-conceived policies and procedures aid execution while out-of-sync ones are barriers.
• Managerial efforts to identify and adopt best practices are a powerful tool for promoting operating excellence and better strategy execution.
• A best practice is any practice that at least one company has proved works particularly well.
• Business process reengineering involves reorganizing the fragmented tasks of a strategy-critical activity into a close-knit group that has charge over the whole process and can be held accountable for performing the activity in a cheaper, better, and/or more strategy-supportive fashion.
• TQM entails creating a total quality culture bent on continuously improving the performance of every task and value chain activity.
• Business process reengineering aims at one time quantum improvement; TQM and six-sigma aim at ongoing incremental improvements.
• The Purpose of using benchmarking, best practices, business process reengineering, TQM, Six Sigma, or other operational improvement programs is to improve the performance of critical activities and enhance strategy execution.
• Innovative, state-of-the-art support systems can be a basis for competitive advantage if they give a firm capabilities that rivals cannot match.
• Having good information systems and operating data are integral to the managerial task of executing strategy successfully and achieving greater operating excellence.
• A properly designed reward structure is management's most powerful tool for mobilizing organizational commitment to successful strategy execution.
• One of management's biggest strategy-executing challenges is to employ motivational techniques that build a wholehearted commitment to operating excellence and winning attitudes among employees.
• A properly designed reward system aligns the well being of organization members with their contributions to competent strategy execution and the achievement of performance targets.
• It is folly to reward one outcome in hopes of getting another outcome. The role of the reward system is to align the well being of organization members with realizing the company's visions, so that organization members benefit by helping the company execute its strategy competently and fully satisfy customers.
• The unwavering standard for judging whether individuals, teams, and organizational units have done a good job must be whether they achieve performance targets consistent with effective strategy execution.
• MBWA is one of the techniques that effective leaders use to stay informed about how well the strategy execution process is progressing.
   

Key Points

Managers implementing and executing a new or different strategy must identify the resource requirements of each new strategic initiative and then consider whether the current pattern of resource allocation and the budgets of the various subunits are suitable. Every organizational unit needs to have the people, equipment, facilities, and other resources to carry out its part of the strategic plan (but no more than what it really needs). Implementing a new strategy often entails shifting resources from one area to another— downsizing units that are overstaffed and over funded, upsizing those more critical to strategic success, and killing projects and activities that are no longer justified. Anytime a company alters its strategy, managers should review existing policies and operating procedures, proactively revise or discard those that are out of sync, and formulate new ones to facilitate execution of new strategic initiatives. Prescribing new or freshly revised policies and operating procedures aids the task of strategy execution (1) by providing top-down guidance to operating managers, supervisory personnel, and employees regarding how certain things need to be done and what the boundaries are on independent actions and decisions; (2) by enforcing consistency in how particular strategy-critical activities are performed in geographically scattered operating units; and (3) by promoting the creation of a work climate and corporate culture that fosters good strategy execution. Thick policy manuals are usually unnecessary. Indeed, when individual creativity and initiative are more essential to good execution than standardization and conformity, it is better to give people the freedom to do things however they see fit and hold them accountable for good results rather than try to control their behavior with policies and guidelines for every situation.

Competent strategy execution entails visible, unyielding managerial commitment to best practices and continuous improvement. Benchmarking, the discovery and adoption of best practices, reengineering core business processes, and continuous improvement initiatives like total quality management (TQM) or Six-Sigma programs all aim at improved efficiency, lower costs, better product quality, and greater customer satisfaction. These initiatives are important tools for learning how to execute a strategy more proficiently. Benchmarking, part of the process of discovering best practices, provides a realistic basis for setting performance targets. Instituting "best-in-industry" or "best-in-world" operating practices in most or all value chain activities provides a means for taking strategy execution to a higher plateau of competence and nurturing a high-performance work environment. Business process reengineering is a way to make quantum progress toward becoming a world-class organization, while TQM and Six- Sigma programs instill a commitment to continuous improvement and operating excellence. An organization bent on continuous improvement is a valuable competitive asset—one that, over time, can yield important competitive capabilities (in reducing costs, speeding new products to market, or improving product quality, service, or customer satisfaction) and be a source of competitive advantage.

Company strategies can't be implemented or executed well without a number of support systems to carry on business operations. Well-conceived state-of-the-art support systems can not only facilitate better strategy execution but also strengthen organizational capabilities enough to provide a competitive edge over rivals. In the age of the Internet, real-time information and control systems, growing use of e-commerce technologies and business practices, company intranets, and wireless communications capabilities, companies can't hope to out execute their competitors without cutting-edge information systems and technologically sophisticated operating capabilities that enable fast, efficient, and effective organization action.

Strategy-supportive motivational practices and reward systems are powerful management tools for gaining employee commitment. The key to creating a reward system that promotes good strategy execution is to make strategically relevant measures of performance the dominating basis for designing incentives, evaluating individual and group efforts, and handing out rewards. Positive motivational practices generally work better than negative ones, but there is a place for both. There's also a place for both monetary and nonmonetary incentives.

For an incentive compensation system to work well, (1) the monetary payoff should be a major percentage of the compensation package, (2) the use of incentives should extend to all managers and workers, (3) the system should be administered with care and fairness, (4) the incentives should be linked to performance targets spelled out in the strategic plan, (5) each individual's performance targets should involve outcomes the person can personally affect, (6) rewards should promptly follow the determination of good performance, (7) monetary rewards should be supplemented with liberal use of nonmonetary rewards, and (8) skirting the system to reward nonperformers or subpar results should be scrupulously avoided.

Successful managers do several things in leading the drive for good strategy execution and operating excellence. First, they stay on top of things. They keep a finger on the organization's pulse by spending considerable time outside their offices, listening and talking to organization members, coaching, cheerleading, and picking up important information. Second, they are active and visible in putting constructive pressure on the organization to achieve good results and operating excellence. This entails (1) promoting an esprit de corps that mobilizes and energizes organization members to execute strategy in a competent fashion and deliver the targeted results and (2) championing innovative ideas for improvement and promoting the use of best practices and benchmarking to measure the progress being made in performing value chain activities in first-rate fashion. Third, wise leaders exert their clout in developing competencies and competitive capabilities that enable better execution. Fourth, they serve as a role model in displaying high ethical standards, and they insist that company personnel conduct the company's business ethically and in a socially responsible manner. They demonstrate unequivocal and visible commitment to the ethics enforcement process. Fifth and finally, when a company's strategy execution effort is not delivering good results and the organization is not making measurable progress toward operating excellence, it is the leader's responsibility to step forward and push corrective actions.

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