What Determines the Type of Strategy a Firm Adopts?
Strategy is derived from the vision and mission of an organisation. Having a strategy allows the organisation to gain competitive advantage against its competitor and assist them to adapt themselves in the changing market. Therefore, the determinants of strategy are an important aspect to consider as they influence the type of strategy a firm adopts in different levels; corporate, business and functional of the organisation. There are many determinants that can affect the type of strategy an organisation adopts, but there are three important ones which firms emphasize heavily on in the strategic management process.
The three determinants are the competition they face in the micro environment, the resource of an organisation as well as the mission and objectives of the organisation in the internal environment. Organisations have control over these determinants as they are closely related to the organisation. By identifying and understanding the determinants of strategy, this will allow the organisation to plan and implement strategies to ensure long-term growth and survival. A competitive advantage is an advantage over the competitor, gained by offering consumers greater value.
In a business an organisation operates, the strategies they implement are mostly driven by competition (Porter, 2008). Competitions are seen as threats, which hinder an organisation’s growth, profit and position in the market. In the article of Porter’s five forces that will shape strategy, three of them refers to competition from external sources, which Porter (2008) refers to as the micro environment. They are the threat of new entrant, threat of substitute products or services and rivalry among competing organisation, which will be discussed. The other two forces that are bargaining power of customers and suppliers.
Porter’s five forces theory emphasizes on the external impact on strategy formulation and advises organisations to evaluate these forces in an industry to position themselves in the market. This theory is generally used in the analysis of an industry and development of business strategy. It also suggests that, in the corporate level, the objective of the corporate strategy should be superior profitability and manage these forces to improve the position of the organisation in the market. Profitable markets that yield high returns will attract new entrants who pose as a threat to existing competitors in the market.
The reason is that when there are more competitions, the increased in production capacity without a concurrent increase in consumer demand will cause a decrease in the overall market profitability. Existing firms in the market will have their position and market share threaten, directly impact on their profitability. These new entrants will try to enter the market, bringing new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete (Porter, 2008).
An example of this situation was when Aldi, a German owned company entered the grocery market with a low-price strategy, they gained a market share about 6% thus putting pressure on the existing company like Coles and Woolworth. The entry barrier thus became an important factor to consider as a low entry barrier will make it easier for new firms to enter the market and vice versa. To counter the threat of new entrants, managers from the corporate and business level has to adopt strategies to prevent them from entering the market.
The strategy option they may adopt in the business level might be a differential strategy which is to differentiate their product or a cost leadership strategy which is lowering their product cost to raise the entry barrier. The threat of substitute products and services according to Porter (2008) are not competitors’ similar products or services but are entirely different. For example, Pepsi in this case is not considered a substitute for Coca-Cola but for water, milk or tea. The substitute can be a totally different product, but it can still satisfy the needs and wants of the customers.
For instance, a customer wanted to buy a bouquet of roses for his wife but change his mind and bought a ring instead. The ring, therefore, indirectly became a substitute for the roses. These substitutes increase the risk of customers to switch to alternatives, which will result in the decline in sales. “When the threat of substitutes is high, industry pro? tability suffers” (Porter, 2008, p84). Unless organisations distance itself from substitutes with product performance, cost, marketing, or other means, it will suffer in terms of pro? ability and often growth potential. A good example is providers of long-distance telephone service. They had suffered a decline of users when inexpensive internet-based phone service such as Skype was introduced. Therefore, the organisation has to adopt a business strategy to counter this threat. An organisation might choose to adopt a differentiation strategy to seek competitive advantage through uniqueness (Schermerhorn, 2011). This strategy emphasizes in developing their product and services that are clearly different and unique compare to the potential substitute.
Rivalry among existing competitors takes on many forms, including price discounting, new product introductions, advertising campaigns, and service improvements (Porter, 2008). The intensity of rivalry among competitors in an industry refers to the extent to which firms within an industry put pressure on one another and limit each other’s profit potential. If rivalry is intense, competitors will try to divert profit and market share from one another. This reduces profit potential for all firms within the industry.
Porter (2008) argues that there are several factors that determine the intensity of competitive rivalry in an industry. If the industry consists of numerous competitors and competitors are of equal size or market share, the intensity of rivalry will be high. Also, if the industry’s products are undifferentiated or are commodities, rivalry will be intense as they will compete to gain customers. Brand loyalty is also an important factor. If the customer loyalty toward a brand is insignificant and consumer switching costs are low, the competition for market share will be intense.
If competitors are strategically diverse, they position themselves differently from other competitors. An industry with excess production capacity will have greater rivalry among competitors. Lastly, high exit barriers, costs or losses incurred as a result of ceasing operations, will cause intensity of rivalry among industry firms to increase. The resource of an organisation has a huge influence on the strategy they adopt. Examples of resources of an organisation are its employee, infrastructure, funding, knowledge and technology.
The resource of a company is limited, so organisation must plan their strategy based on the capability of their resources. In some cases, although the resource could be lacking, this could actually encourage strategic plan formulation, even if it makes the implementation stage more difficult (Berry & Wechsler, 1995, as cited in Poister, Pitts, & Edwards, 2010). According to the dynamic capability theory; an organisation can gain and sustain competitive advantage if the organisation is able to deploy their resources effectively within its business. Dynamic capability refers to the ability of a ? m to reposition itself in the face of a changing environment (Teece, Pisano, & Shuen, 1997, as cited in Danneels, 2011) by changing its set of resources (Eisenhardt &Martin, 2000, as cited in Danneels,2011). For example, Smith Corona, formerly one of the world’s leading manufacturers of typewriters, was challenged to exercise dynamic capability in the face of the dissipation of its main product category (Danneels, 2011). In order to face this challenge, they adopted a brand extension strategy that is the use of established brand names to enter new product categories (Keller & Aaker, 1992, as cited in Danneels, 2011).
Their first step was leveraging existing resources involves putting them to new uses (Danneels, 2002, 2007; Miller, 2003 as cited in Danneels, 2011). Smith Corona tried to leverage its brand, distribution, and customer understandings in order to enter product categories other than typewriters. Leveraging resources that Kathleen & Sull (2001) discussed in their theory of “Strategy as a simple rule” is one of the approach to strategy. They suggested that by leveraging the resource of a company, it allows them to sustain a competitive advantage in the long-term.
By using the simple rules, priorities can be set for resource allocation among competing opportunities (Kathleen & Sull, 2001). For example, Intel, the computer software manufacturer realized a long time ago that it needed to allocate manufacturing capacity among its products very carefully, given the enormous costs of fabrication facilities. At a time of extreme price volatility in the mid-1980s, when Asian chip manufacturers were disrupting world markets with price cuts and accelerated technological improvement, Intel followed a simple rule which is allocating the manufacturing capacity based on a product’s gross margin.
Without this rule, the company might have continued to allocate too much capacity to its traditional core memory business rather than seizing the opportunity to dominate then ascent and highly profitable microprocessor niche (Kathleen & Sull, 2001). There are many types of resources within a firm, for example, human and financial resource. Human resource refers to the staff employed. An organisation is unable to function without human resource. It is an important aspect to consider because it distinguishes a successful company from an unsuccessful company as the performance of the business relies on the performance of its employee.
Organisations often choose employees based on the qualifications, experience and skills required for the work. In addition to this, they conduct various kinds of training programs so that employees can upgrade their skills and perform better. O’Shannassy (2003) stated that all individuals in the organisation can think strategically, not just the chief executive officer (CEO). Therefore, it is worth the effort to train them to increase the quality of the workforce. This relates to human resource management (HRM).
In the functional level of an organisation, various functional strategies are used to guide the use of resources to implement business strategy effectively. HRM is the strategic and coherent approach to the management of an organization’s most valued assets; its employee. The HRM process is the process of attracting, developing and maintaining a quality workforce (Schermerhorn et al, 2011). It analyses the needs of the staffs and takes action to satisfy these needs. The purpose of HRM is to make sure the organisation always has people with the right abilities available to do the required work (Schermerhorn et al, 2011).
Financial resources concern the ability of the business to finance its chosen strategy. Any project or strategy an organisation deploys requires investment and often risks. For example, a strategy that requires significant investment in new products, distribution channels, production capacity and working capital will place a great strain on the business finances. Therefore, it is important to understand the financial resource of a business and plan strategy based on it.
The SWOT (strength, weaknesses, opportunities and threats) analysis is a technique that can be used to analyse the organisational resources and capabilities. Using this technique, managers from all levels of an organisation will be able to identify the strength and weaknesses of the organisation, therefore, is able to allocate and use the resources effectively. The mission and objectives of an organisation determine the type of strategy it adopts. “The strategic management process begins with a careful assessment and clarification of the organisational mission, values and objectives” (Schermerhorn et al, 2011, p. 218).
A clear sense of mission and objectives act as a starting point for assessing the organisation’s resources and capabilities as well and competitive opportunities and threats in the external environment (Schermerhorn et al, 2011). The mission or purpose of an organisation may be described as its reason for existence in society (Schermerhorn et al, 2011). It sets a direction for the organisation and provides a vision for its business. For example, China announced its objectives in the 21st century was to achieve sustainable levels of development aimed at improving domestic economic and political stability, and to legitimise the continuation of ne-party rule (Schermerhorn et al, 2011). Businesses in China were strongly influenced by the government’s overall mission and by adapting to this mission while competing in the global market, businesses in China had grown strong in the global market. “Whereas a mission statement sets forth an official purpose for the organisation and the core values describe appropriate standards of behavior for its accomplishment, operating objectives direct activities towards specific performance results”(Schermerhorn et al, 2011). With an objective, a corporate strategy can be set based on it, to give a direction as to where the organisation is heading.
An example is, Porter (2008), argues that the ultimate goal for any business or profit seeking organisation should be superior profitability. By having this goal, it will create value for investors in the form of “above average returns”, which is returns that exceed what an investor could earn by investing in alternative opportunities of equivalent risk (Schermerhorn et al, 2011). All organisation except for non for profit organisation are profit driven. A company may have many other objectives, but if there is no profit in the business then they will have to end the business.
So to achieve this objective, at the corporate or business level organisation, they may adopt a growth or diversification strategy. The growth strategy pursues an expansion of the current operation, whereas diversification takes place through acquisition or investment of different business areas (Schmerhorn et al, 2011). With the growth of the business, there will be growth in profit. This can be seen from the rapid growth of the company Boost Juice Bars with the fruit juice as their product. Their mission was to promote healthy living, and their objective is to build Australia’s largest collection of juice bars (Schermerhorn et al, 2011).
They implement their growth strategy by the means of franchising. Franchising is a business relationship in which the franchisor (the owner of the business providing the product or service) assigns to independent people (the franchisees) the right to market and distribute the franchisor’s goods or service, and to use the business brand for a fixed period of time. With franchising, they were able to expand their company throughout Australia as well as other countries. The competition, resources as well as the mission and objectives of an organisation are some of the many determinants of strategy an organisation adopts.
These determinants were all considered to create strategies that enable the organisation to gain competitive advantage over their competitor and effectively utilize the limited resources they have. These determinants discussed are limited to the internal and micro environment which closely relates to the business of an organisation. To fully understand all the aspects on what determines the type of strategy a firm adopts, research on the macro environment where the organisation has no control of, is required.