Here's the writeup I promised. My goal was just to establish a basic level of what strategy is. It seems that every post in this folder is asking how to do strategy. I wouldn't propose that this thought process is the only way to go, but this is the way I've learned it and the way I go through it.
I’m not 100% satisfied with this write up, but I’m going to post it anyway in the interest of moving forward. The information is correct, but I don’t think it flows very well and it’s very dense in information. Nevertheless, please read it through and let me know any questions.
Two initial points:
- Efficiency is not strategy. Efficiency is a measure of how effectively you are able to carry out the strategy. It can be an element of strategy; a certain strategy might require that you become more efficient. Efficiency can be strength. But efficiency is about operations, not strategy.
- Acquisition isn't a strategy. It’s a way to get larger, but if you take a small company with a bad strategy and acquire another company...you wind up with a larger company with a strategy that looks worse. Bad strategies are more flagrantly apparent in bigger firms.
The basic idea of strategy is to go through a thought process about the internal and external forces affecting your company. The result of this process is recognition of the main strengths and weaknesses of the company and the opportunity and threats affecting them. Once these are recognized, the strategy is the plan that charts the course to align the company's strengths to exploit the opportunities, to minimize the weaknesses and threats.
Michael Porter proposes a structure for thinking about strategy that I've found to be very useful in the past. There are four groups of forces acting on a company:
Threat of Entry - the threat that new firms will enter the markets. If its easy for new firms to enter the market, an existing firm has to be vigilant about what new firms are doing and stay flexible enough to react. There are six main barriers to entry
- Economies of scale - in certain industries, you have to be big or accept a cost disadvantage. The cost disadvantage is a barrier to the new firm.
- Product differentiation - How does a new entry differentiate itself?
- Capital requirements - There are some firms that are expensive to start, a new steel mill for example.
- Cost disadvantages independent of size - entrenched companies have advantages of knowledge, processes and relationships. New companies have to spend money to establish these.
- Access to distribution channels - This is tied to the previous one, but also includes the significant outlay required for distribution.
- Government policy - in a regulated industry, it may be very difficult to enter.
Power of Suppliers - how much leverage do suppliers have to raise prices? Suppliers are considered powerful if they:
- Are dominated by a few companies
- Sell a unique product or one with high switching costs
- Is not obligated to contend with competition in another sector
- Poses a credible threat of forward integration
- The firm is not a significant customer.
Power of Buyers - how much leverage do your customers have to demand lower prices? Buyers are powerful if they:
- Purchase in large volumes
- Are purchasing a standard product
- Are purchasing a product as a component of a larger product and the component is not a significant cost in the larger product
- The buyer has low profits
- The firm's product isn't important to the customer's service quality
- The firm's product does not save the customer money
- The buyer poses a threat of backward integration.
Threat of substitutes: If another product can be easily substituted for yours, you need to monitor the comparison products.
- Over time the price/performance measure will change.
- Is there a rapidly developing industry?
- What are the switching costs?
- customer satisfaction and loyalty are very relevant.
All these create a fifth force, Rivalry between firms. I think of Rivalry as the measure of chaos in the industry. There is higher rivalry when
- There are lots of competitors
- The growth of the industry is low
- Poorly differentiated product
- Low switching cost products
- High fixed costs
- Perishable products
- Capacity has to be added in large increments (you can't start 1/10th of a factory)
- There are high costs to get out of the business.
Decide each of these factors for the business. The answers tell you the Strengths, Weaknesses, Opportunities and Threats (SWOT) for the business. The next sounds like a leap of faith until you do it: you create a plan that leverages the Strengths to exploit the Opportunities. The plan should minimize exposure to Threats and mitigate the weaknesses.
That's really it. You normally want data to back up your conclusions, but an informal purpose, your industry understanding will suffice. Please post any questions.