Strategy: Core Concepts and Analytical Approaches

Arthur A. Thompson, The University of Alabama 7th Edition, 2022-2023

An e-book marketed by McGraw Hill Education

Chapter 1
What Is Strategy
and Why Is It Important?
Strategy means making clear-cut choices about how to compete.
—Jack Welch, former CEO, General Electric

Without a strategy the organization is like a ship without a rudder.

—Joel Ross and Michael Kami

If your firm’s strategy can be applied to any other firm, you don’t have a very good one.
—David J. Collis and Michael G. Rukstad

In business, strategy is king. Leadership and hard work are all very well and luck is mighty useful, but it
is strategy that makes or breaks a firm.
—The Economist, a leading publication on economics, business, and international affairs

M
anagers of all types of businesses face three central questions: What’s our company’s present situation?
What should the company’s future direction be and what performance targets should we set? What’s
our plan for running the company and producing good results? Arriving at a thoughtful and probing
answer to the question “What’s our company’s present situation?” prompts managers to evaluate industry
conditions and competitive pressures, the company’s current market standing, its competitive strengths
and weaknesses, and its future prospects in light of changes taking place in the business environment. The
question “What should the company’s future direction be and what performance targets should we set?”
pushes managers to consider what emerging buyer needs to try to satisfy, which growth opportunities to
pursue most vigorously, which existing markets to de-emphasize or even abandon, what strategic path to
follow, and what outcomes the company should strive to achieve with respect to both its financial performance
and its performance in the markets where it competes. The question “What’s our plan for running the company
and producing good results?” challenges managers to craft a series of competitive moves and business
approaches—what henceforth will be referred to as the company’s strategy—for heading the company in the
intended direction, staking out a market position, attracting customers, and achieving the targeted financial
and market performance.

The role of this chapter is to define the concept of strategy, identify the kinds of actions that determine what
a company’s strategy is, introduce you to the concept of competitive advantage, and explore the tight linkage
between a company’s strategy and its quest for competitive advantage. We will also explain why company

1
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 Chapter 1 • What Is Strategy and Why Is It Important? 2

strategies are partly proactive and partly reactive, why they evolve over time, and the relationship between a
company’s strategy and its business model. We conclude the chapter with a discussion of what sets a winning
strategy apart from a ho-hum or flawed strategy and why the caliber of a company’s strategy determines
whether it will enjoy a competitive advantage or be burdened by competitive disadvantage. By the end of the
chapter, you will have a clear idea of why the tasks of crafting and executing strategy are core management
functions and why excellent execution of an excellent strategy is the most reliable recipe for turning a company
into a standout performer over the long term.

WHAT DO WE MEAN BY “STRATEGY”?

A company’s strategy is defined by the specific market
positioning, competitive moves, and business approaches CORE CONCEPT
that form management’s answer to “What’s our plan for A company’s strategy consists of the competitive
running the company and producing good results?” A moves and business approaches that managers
strategy represents managerial commitment to undertake employ to attract and please customers, compete
one set of actions rather than another in an effort to
successfully, grow the business, respond to
compete successfully and achieve good performance
changing market conditions, conduct operations,
outcomes.1 This commitment incorporates a coherent
collection of choices and decisions about: and achieve the targeted financial and market
performance.
• How to attract and please customers.
• How to compete against rivals—and, ideally, gain a competitive advantage as opposed to being
hamstrung by competitive disadvantage.
• How to position the company in the marketplace vis-à-vis rivals.
• How to capitalize on opportunities to grow the business.
• How best to respond to changing economic and market conditions.
• How to manage each functional piece of the business (e.g., R&D, supply chain activities, production,
sales and marketing, distribution, finance, and human resources).
• How to achieve the company’s performance targets.

In effect, when managers craft a company’s strategy, they are saying, “Among the many different business
approaches and ways of competing we could have chosen, we have decided to employ this particular
combination of competitive and operating approaches in moving the company in the intended direction,
strengthening its market position and competitiveness, and meeting or beating our performance objectives.”
Choosing among the various alternative hows is often tough, involving difficult trade-offs and sometimes high
risk. But that is no excuse for company managers failing to decide upon a concrete course of action that spells
out “This is the strategic path we are going to take and here’s what we are going to do to pursue competitive
success in the marketplace and achieve good business results.”2

In most industries, company managers have considerable leeway in choosing the hows of strategy. For
example, managers may see a promising opportunity for the company to compete against rivals by striving
to keep costs low and selling products/services at attractively low prices. Often, there is room for a company
to pursue competitive success by offering buyers more features, better performance, longer durability, more
personalized customer service, and/or quicker delivery. Many companies strive to gain a competitive edge
over rivals via cutting-edge technological features, longer warranties, clever advertising, better brand-name
recognition, or the development of competencies and capabilities rivals cannot match. But it is foolhardy to
pursue all of these options simultaneously in an attempt to be all things to all buyers. Choices of how best
to compete against rivals have to be made in light of the firm’s resources and capabilities and in light of the
competitive approaches rival companies are employing.

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 Chapter 1 • What Is Strategy and Why Is It Important? 3

Likewise, there are all kinds of market-positioning options.3 Some companies target buyers looking for top quality,
multifeatured products and willing to pay premium prices for them whereas other companies focus their efforts
on appealing to buyers who prefer good to average products sold at average or slightly above-average prices,
and still other companies strive to capture the business of
shoppers looking for basic products with attractively low There’s no one roadmap or prescription for
price tags. Some business enterprises position themselves
running a business in a successful manner. Many
to compete in many market segments, endeavoring to
different avenues exist for competing successfully,
attract many types of buyers with a wide variety of models
and styles sold at different price points; other companies staking out a market position, and operating the
focus on a single market segment, with product offerings different pieces of a business.
specifically designed to meet the needs and preferences
of a particular buyer type or buyer demographic. Some
companies position themselves in only one part of the industry’s chain of production/distribution activities
(preferring to operate only in manufacturing or wholesale distribution or retailing), whereas others are partially
or fully integrated, with operations ranging from components production to manufacturing and assembly to
wholesale distribution to retailing. Some companies confine their operations to local or regional markets;
others opt to compete nationally, internationally (in several countries), or globally (in all or most of the major
country markets worldwide). Some companies decide to operate in only one industry, whereas others diversify
broadly or narrowly into related or unrelated industries via acquisitions, joint ventures, strategic alliances, or
starting up new businesses internally.

Strategy Is About Competing Differently Mimicking the strategies of successful industry rivals—with
either copycat product offerings or maneuvers to stake out the same market position—rarely works. The best
performing strategies are aimed at competing differently. This does not mean that the key elements of a
company’s strategy have to be 100 percent different but rather that they must differ in at least some important
respects that matter to buyers. A strategy stands a better chance of succeeding when it is predicated on actions,
business approaches, and competitive moves aimed at
(1) appealing to buyers in ways that set a company apart A creative, distinctive strategy that sets a
from its rivals—particularly when it comes to doing what company apart from rivals and delivers superior
rivals don’t do or, even better, doing what they can’t do value to customers is a company’s most reliable
and (2) staking out a market position that is not crowded ticket for winning a competitive advantage over
with strong competitors. Really successful strategies often rivals.
contain some distinctive “a-ha!” quality that goes beyond
merely attracting buyer attention but that, more importantly,
delivers what an attractively an large number of buyers perceive as superior value and converts them into loyal
customers. Indeed, the more a strategy is aimed at competing differently in ways that deliver superior value to
buyers, the more likely the strategy will produce a valuable competitive edge over rivals.4

STRATEGY AND THE QUEST FOR COMPETITIVE

ADVANTAGE
The heart and soul of any strategy are the actions and moves in the marketplace that managers are taking
to gain a competitive advantage over rivals. A company achieves a competitive advantage whenever it has
some type of edge over rivals in attracting buyers and coping with competitive forces. There are many routes
to competitive advantage, but they all involve providing a distinct buyer segment with what segment members
perceive as superior value compared to the offerings of rival sellers. Superior value can mean a good product
at a lower price, a superior product that is worth paying more for, or a best-value offering that represents an
appealing combination of features, quality, service, and other attributes at an attractively low price. Five of the
most frequently used and dependable strategic approaches to setting a company apart from rivals, delivering
superior value, achieving competitive advantage, and converting buyers into loyal customers are:

1. Striving to be the industry’s low-cost provider, thereby aiming for a cost-based competitive advantage
over rivals that can then become the basis for charging lower prices and/or earning higher profits.
Walmart and Southwest Airlines have earned strong market positions because of the low-cost advantages

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 Chapter 1 • What Is Strategy and Why Is It Important? 4

they have achieved over their rivals and their consequent ability to underprice competitors. Achieving
lower costs than rivals can produce a durable competitive edge when rivals find it hard to match the low-
cost leader’s approaches to driving costs out of its business.
2. Competing successfully and profitably against rivals based on differentiating features such as higher
quality, wider product selection, added performance, value-added services, more attractive styling,
technological superiority, or some other attributes that set a company’s product offering apart from
those of rivals. Successful adopters of differentiation strategies include Apple (innovative products),
Johnson & Johnson in baby products (product reliability), Chanel and Rolex (top-of-the-line prestige),
and Mercedes and BMW (engineering design and performance). Differentiation strategies can be
powerful as long as a company is sufficiently innovative to thwart the efforts of clever rivals to copy or
closely imitate its product offering and means of delivering superior value.
3. Offering more value for the money. Giving customers more value for their money by meeting or beating
buyers’ expectations regarding key quality/features/performance/service attributes while beating their
price expectations is known as a best-cost provider strategy. This approach is a hybrid strategy that
blends elements of the previous approaches. Toyota employs a best-cost provider strategy for its Lexus
line of motor vehicles, as does Honda for its Acura line of cars and SUVs. Many consumers shop at
L.L. Bean because of the good value it delivers: products with appealing quality/performance/features/
styling and attractively low prices. Likewise, Amazon.com has been highly successful in attracting
customers with its more-value-for-the-money combination of appealing prices, wide selection, free
shipping, extensive product information and reviews, and online shopping convenience.
4. Focusing on a narrow market niche and winning a competitive edge by doing a better job than rivals
of serving the special needs and tastes of buyers that compose the niche. Prominent companies that
enjoy competitive success in a specialized market niche include eBay in online auctions, Jiffy Lube
International in quick oil changes, and The Weather Channel in cable TV.
5. Developing competitively valuable resources and capabilities that rivals can’t easily imitate or trump
with resources or capabilities of their own. FedEx has superior capabilities in next-day delivery of
small packages. Walt Disney has hard-to-beat capabilities in theme park management and family
entertainment. Apple has formidable capabilities in innovative product design. Ritz-Carlton and
Four Seasons have uniquely strong capabilities in providing their hotel guests with an array of
personalized services. Hyundai has become the world’s fastest-growing automaker as a result of its
advanced manufacturing processes and unparalleled quality control systems. Very often, winning
a durable competitive edge over rivals hinges more on building competitively valuable resources
and capabilities than it does on having a distinctive product. Clever rivals can nearly always copy
the attributes of a popular or innovative product, but for rivals to match experience, know-how, and
specialized competitive capabilities that a company has developed and perfected over a long period
of time is substantially harder to duplicate and takes much longer.

Forging a strategy that produces a competitive advantage

has great appeal because it enhances a company’s CORE CONCEPT
financial performance. A company is almost certain A company achieves competitive advantage
to earn significantly higher profits when it enjoys a when an attractive number of buyers are drawn
competitive advantage as opposed to when it competes to purchase its products or services rather than
with no advantage or is hamstrung by competitive
those of competitors. A company achieves
disadvantage. Competitive advantage is the key to above-
sustainable competitive advantage when the
average profitability and financial performance because
strong buyer preferences for a company’s products or basis for buyer preferences for its product offering
services translate into higher sales volumes (Walmart) relative to the offerings of its rivals is durable,
and/or the ability to command a higher price (Häagen- despite competitors’ efforts to nullify or overcome
Dazs), which in turn tend to improve earnings, return the appeal of its product offering.
on investment, and other important financial outcomes.
Furthermore, if a company’s competitive edge holds
promise for being sustainable (as opposed to just temporary), then so much the better for both the strategy

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 Chapter 1 • What Is Strategy and Why Is It Important? 5

and the company’s future profitability. What makes a competitive advantage sustainable (or durable) as
opposed to temporary are actions and elements in the strategy that cause an attractive number of buyers
to have lasting reasons to purchase a company’s products or services, despite competitors’ best efforts to
nullify or overcome those reasons.

The tight connection between competitive advantage and profitability means the quest for sustainable
competitive advantage is typically the foremost consideration in choosing the central elements of a company’s
strategy. Indeed, the competitive power of a company’s strategy is governed by one or more differentiating
attributes or strategy elements that act as a magnet to draw customers and give them strong and often durable
reasons to prefer its products or services. Thus, what separates a powerful strategy from a run-of-the-mill or
ineffective one is management’s ability to forge a series of moves, both in the marketplace and internally,
which tilts the playing field in the company’s favor and produces a sustainable competitive advantage over
rivals. The bigger and more sustainable the competitive advantage, the better a company’s prospects for
winning in the marketplace and earning superior long-term profits relative to its rivals. Without a strategy that
leads to competitive advantage, a company risks being outcompeted by more strategically astute rivals and/or
handcuffed by mediocre sales and uninspiring financial results.

Identifying a Company’s Strategy

The best indicators of a company’s strategy are its actions in the marketplace and senior managers’ statements
about the company’s current business approaches, future plans, and efforts to strengthen its competitiveness
and performance. Figure 1.1 shows what to look for in identifying the key elements of a company’s strategy.

Once it is clear what to consider, the task of identifying a company’s strategy is mainly one of researching the
company’s actions in the marketplace and its business approaches. In the case of publicly owned enterprises,
senior executives often openly discuss the strategy in the company’s annual report and 10-K report, in press
releases and company news (posted on the company’s website), and in the information provided to investors on
the company’s website. To maintain the confidence of investors and Wall Street, most public companies are fairly
open about their strategies. Company executives typically lay out key elements of their strategies in presentations
to securities analysts (portions of which are usually posted in the investor relations section of the company’s
website), and stories in the business media about the company often include aspects of the company’s strategy.
Hence, except for some about-to-be-launched moves and changes that remain under wraps and in the planning
stage, there’s usually nothing secret or undiscoverable about a company’s present strategy.

FIGURE 1.1 Identifying a Company’s Strategy—What to Look For

Actions to diversify the company’s Actions to compete more successfully and profitably by
revenues and earnings by reducing unit costs below those of rivals and very likely
entering new businesses charging lower prices
Actions to compete more successfully and
Actions to upgrade, build, profitably by offering buyers more or better
or acquire competitively valuable performance features, more appealing
resources and capabilities or to design, higher quality, better customer
correct competitive weaknesses service, wider product selection, or other
attributes that enhance buyer appeal
The Pattern
Actions and approaches used of Actions and Actions to enter new product
in managing R&D, production, segments or geographic markets
sales and marketing, finance, Business Approaches or to exit existing ones
and other key activities that Define a
Company’s
Actions to strengthen market Strategy
standing or competitiveness via Actions to respond/adjust to
mergers, acquisitions, strategic changing market and competitive
alliances, and/or collaborative conditions or other external factors
partnerships
Actions to strengthen public image
Actions to capture emerging market and reputation via corporate social
opportunities and defend against external responsibility initiatives and environmental
threats to the company’s business prospects efforts to protect the planet

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 Chapter 1 • What Is Strategy and Why Is It Important? 6

Why a Company’s Strategy Evolves Over Time

All companies, sooner or later, find it necessary to modify aspects of their strategy in response to changing
market conditions, advancing technology, the fresh moves of competitors, shifting buyer needs and preferences,
emerging market opportunities, new ideas for improving
the strategy, and/or mounting evidence that certain aspects CORE CONCEPT
of the present strategy are no longer working well. Most of
the time, a company’s strategy evolves incrementally from Changing circumstances and ongoing
management’s ongoing efforts to fine-tune this or that piece management efforts to improve the strategy
of the strategy and to adjust certain strategy elements in cause a company’s strategy to evolve over time
response to new learning and unfolding events.5 However, —a condition that makes the task of crafting a
on occasion, major strategy shifts are called for, such as strategy a work in progress, not a one-time or
when a strategy is clearly failing, market conditions or buyer every-now-and-then event.
preferences suddenly change dramatically, or important
technological breakthroughs occur (as in medical devices,
solar energy, and self-driving vehicles). In some industries, conditions change at a fairly slow pace, making it
feasible for the major components of a good strategy to remain in place for long periods. But in industries like
microelectronics and semi-conductors, electric vehicle manufacture, and genetic engineering where market
conditions and technological capabilities change frequently and in sometimes dramatic ways, the life cycle
of a given strategy is short. It is not uncommon for companies in high-velocity environments to overhaul key
elements of their strategies several times a year or even to “reinvent” how they intend to compete differently
from rivals and deliver superior value to customers.6

Regardless of whether a company’s strategy changes gradually or swiftly, the important point is that its
present strategy is always temporary and on trial, pending management’s next round of strategy initiatives, the
emergence of new industry and competitive conditions, and other unfolding developments that management
believes warrant strategy adjustments. Thus, a company’s strategy at any given point is fluid, representing the
temporary outcome of an ongoing process that, on the one hand, involves reasoned and creative management
efforts to craft a competitively effective strategy and, on the other hand, involves ongoing responses to market
change and constant experimentation and tinkering. Adapting to new conditions and constantly evaluating
what is working well enough to continue and what needs to be improved are normal parts of the strategy-
making process and result in an evolving strategy.7

A COMPANY’S STRATEGY IS PARTLY PROACTIVE

AND PARTLY REACTIVE
The evolving nature of a company’s strategy means the typical company strategy is a blend of (1) proactive
actions to secure a competitive edge and improve the company’s financial performance and (2) as-needed
reactions to fresh market conditions and other unanticipated developments—see Figure 1.2.8 The biggest
portion of a company’s current strategy usually consists of a combination of previously initiated actions and
business approaches that are working well enough to merit continuation and newly launched initiatives aimed
at boosting competitive success and financial performance. Typically, managers proactively modify one or
more aspects of their strategy as new learning emerges about which pieces of the strategy are working well
and which aren’t and as they explore and test new ways to improve the strategy. This part of management’s
action plan for running the company is deliberate and constitute its proactive strategy elements.

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 Chapter 1 • What Is Strategy and Why Is It Important? 7

FIGURE 1.2 A Company’s Strategy Is a Blend of Proactive Initiatives and

Reactive Adjustments

Abandoned
strategy elements

Proactive Strategy Elements

Newly-crafted strategic initiatives

Prior plus ongoing strategy elements Latest
Version continued from prior periods
Version
of
of
Company
Company
Strategy
New strategy elements that emerge Strategy
as managers react to changing
circumstances

Reactive Strategy Elements

But managers must always be willing to supplement or modify all the proactive strategy elements with as-
needed reactions to fresh or unexpected developments. Inevitably, there will be occasions when market and
competitive conditions take an unexpected turn that call for some kind of strategic reaction or adjustment.
Hence, a portion of a company’s strategy is always developed on the fly, coming as a response to fresh strategic
maneuvers on the part of rival firms, unexpected shifts in customer requirements and expectations, important
technological developments, newly appearing market opportunities, a changing political or economic climate,
or other unanticipated happenings in the surrounding environment. These adaptive strategy adjustments form
the reactive strategy elements.

As shown in Figure 1.2, a company’s strategy evolves from one version to the next as managers abandon
obsolete or ineffective strategy elements, settle upon a set of proactive strategy elements, and then—as new
circumstances unfold—make adaptive strategic adjustments, all of which result in an assortment of reactive
strategy elements. The latest version of a company’s strategy thus reflects the disappearance of obsolete or
ineffective strategy elements and a modified combination of proactive and reactive elements.

STRATEGY AND ETHICS: PASSING THE TEST

OF MORAL SCRUTINY
In choosing among strategic alternatives, company mana-
gers are well advised to embrace actions that can pass the CORE CONCEPT
test of moral scrutiny. Just keeping a company’s strategic A strategy cannot be considered ethical just
actions within the bounds of what is legal does not mean
because it involves actions that are legal. To
the strategy is ethical. Ethical and moral standards are
meet the standard of being ethical, a strategy
not fully governed by what is legal. Rather, they involve
issues of “right” versus “wrong” and duty—what one must entail actions and behavior that can pass
should do. A strategy is ethical only if it does not entail moral scrutiny in the sense of not being deceitful,
actions and behaviors that cross the moral line from unfair or harmful to others, disreputable, or
“can do” to “should not do.” For example, a company’s unreasonably damaging to the environment.
strategy definitely crosses into the should not do

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 Chapter 1 • What Is Strategy and Why Is It Important? 8

zone and cannot pass moral scrutiny if it entails actions and behaviors that are deceitful, unfair or harmful
to others, disreputable, or unreasonably damaging to the environment. A company’s strategic actions or
behavior cross over into the should not do zone and are likely to be deemed unethical when (1) they reflect
badly on the company or (2) they adversely impact the legitimate interests and well-being of shareholders,
customers, employees, suppliers, the communities where it operates, and society at large or (3) they provoke
widespread public outcries about inappropriate or “irresponsible” actions, behavior, or outcomes.

Admittedly, it is not always easy to categorize a given strategic behavior as ethical or unethical. Many strategic
actions fall in a gray zone and can be deemed ethical or unethical depending on how high one sets the bar
for what qualifies as ethical behavior. For example, is it ethical for advertisers of alcoholic products to place
ads in media having an audience of as much as 50 percent underage viewers? Is it ethical for an apparel
retailer attempting to keep prices attractively low to source clothing from manufacturers who pay substandard
wages, use child labor, or subject workers to unsafe working conditions? Is it ethical for Nike, Under Armour,
and other makers of athletic uniforms and other sports gear to pay a university athletic department large sums
of money as an “inducement” for the university’s athletic teams to use their brand of products? Is it ethical for
pharmaceutical manufacturers to charge higher prices for life-saving drugs in some countries than they charge
in others? Is it ethical for a company to ignore the damage its operations do to the environment in a particular
country, even though its operations are in compliance with current environmental regulations in that country?

Senior executives with strong ethical convictions are generally proactive in linking strategic action and ethics;
they forbid the pursuit of ethically questionable business opportunities and insist that all aspects of company
strategy are in accord with high ethical standards. They make it clear that all company personnel are expected
to act with integrity, and they put organizational checks and balances into place to monitor behavior, enforce
ethical codes of conduct, and provide guidance to employees regarding any gray areas. Their commitment to
ethical business conduct is genuine, not hypocritical lip service.

The reputational and financial damage that unethical strategies and behavior can do is substantial. When a
company is put in the public spotlight because certain personnel are alleged to have engaged in misdeeds,
unethical behavior, fraudulent accounting, or criminal behavior, its revenues and stock price are usually
hammered hard. Many customers and suppliers shy away from doing business with a company that engages
in sleazy practices or turns a blind eye to its employees’ illegal or unethical behavior. They are turned off by
unethical strategies or behavior and, rather than become victims or get burned themselves, wary customers
take their business elsewhere and wary suppliers tread carefully. Moreover, employees with character and
integrity do not want to work for a company whose strategies are shady or whose executives lack character
and integrity. Besides, immoral or unethical actions are just plain wrong. Consequently, there are solid business
reasons why companies should avoid employing unethical strategy elements.

THE RELATIONSHIP BETWEEN A COMPANY’S STRATEGY

AND ITS BUSINESS MODEL
Closely related to the concept of strategy is the concept
of a company’s business model. A business model is CORE CONCEPT
management’s blueprint for delivering a valuable product A company’s business model sets forth how
or service to customers in a manner that will generate its strategy and operating approaches will
revenues sufficient to cover costs and yield an attractive create value for customers while at the same
profit.9 The two main components of a company’s business
time generating ample revenues to cover costs
model are (1) its customer value proposition and (2) its
and realize a profit large enough to please
profit proposition (or “profit formula”).10 The customer value
proposition lays out the company’s approach to satisfying shareholders. Absent the ability to earn good
buyer needs and requirements at a price they will consider profits, a company’s strategy and operating
a good value.11 Plainly, from a customer perspective, the blueprint are flawed, its business model is not
greater the value delivered and the lower the price to viable, and its ability to survive is in jeopardy.
get this value, the more appealing the company’s value

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 Chapter 1 • What Is Strategy and Why Is It Important? 9

proposition and product offering. From a company perspective, however, the greater the value delivered and
the higher the price that can be charged, the bigger the margin for covering the costs associated with its
business approach and realizing an attractive profit and return on investment.

The profit proposition or profit formula portion of a company’s business model concerns its business approach
to generating sufficiently large revenues and controlling the costs of its customer value proposition, such that
the company will be able to simultaneously deliver the intended value to customers and deliver appealing
profits to shareholders. For a company’s business model to result in both satisfied customers and satisfied
shareholders, three outcomes are required:

• The revenue stream that is generated must be big enough to more than cover the costs of delivering
attractive value to customers. The revenues that can be generated are a function of the volume of
customers attracted at the price being charged.

• There must be adequate ways and means to control the costs of the value being delivered to
customers. The costs of the company’s business model approach are dependent on the costs of the
resources and business processes it utilizes and the cost efficiency of its operating systems.

• The amounts by which revenues exceed the costs incurred must please shareholders.

The lower a firm’s costs are in relation to its revenues, the greater its profit potential and the more attractive its
profit proposition.

Magazines and newspapers employ a business model keyed to delivering information and entertainment they
believe readers will find valuable and a profit formula aimed at securing sufficient revenues from subscriptions
and advertising to more than cover the costs of producing and delivering their content to readers. Cell-phone
providers, satellite radio companies, and Internet service providers also employ a subscription-based business
model. The business model of network TV and radio broadcasters entails providing free programming to
audiences but charging advertising fees based on audience size; profit is realized by generating sufficient
advertising revenues to more than cover programming costs. Gillette’s business model in razor blades involves
selling a “master product”—the razor—at an attractively low price and then making money on repeat purchases
of razor blades that can be produced cheaply and sold at high profit margins. Printer manufacturers like
Hewlett-Packard, Canon, Dell, and Epson pursue much the same business model as Gillette—selling printers at
a low (virtually breakeven) price and making large profit margins on the repeat purchases of ink cartridges and
other printer supplies. McDonald’s invented the business model for fast food—providing value to customers
in the form of economical quick-service meals at clean, convenient locations. Its profit formula involves such
elements as standardized cost-efficient store designs; ongoing expenditures for ever-better equipment and
food preparation systems that enable serving hot, good-tasting food faster and accurately; extensive testing
of new menu items; stringent specifications for ingredients; detailed operating procedures for each unit; heavy
reliance on advertising and in-store promotions to drive volume; and sizable investment in human resources
and training.

Amazon.com mainly utilizes an online direct sales business model whereby it procures merchandise for display
and sale on its web pages, provides an online marketplace for some 5 million third-party merchants from which
it derives service fees and/or sales commissions, and operates a growing network of geographically scattered
distribution centers that rapidly fill, package, and ship customer orders for delivery by third-party carriers (FedEx,
UPS, and the U.S. Postal Service). Amazon’s affiliated merchants can either use Amazon’s order fulfillment
capabilities or perform these activities themselves. Third-party sellers accounted for 58 percent of total physical
gross merchandise sales on Amazon in 2018, up from just 3 percent in 1999.12 However, Chinese-based Alibaba
has adopted a “platform” business model whereby it operates online and mobile shopping marketplaces for
consumers, merchants, and third-party service providers to conduct online retail and wholesale trade; Alibaba’s
revenues come from the commissions and fees it earns on the hundreds of millions of transactions annually
made by the merchants using its web-based sales platform and associated services (that includes web-page
display, auction hosting, online money transfer, cloud computing, and logistics, among others). Beginning in
2019, however, Alibaba did begin to offer procurement services for foreign firms attempting to enter the Chinese
online marketplace and order fulfillment services for domestic online sellers on sales made outside China. So

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 Chapter 1 • What Is Strategy and Why Is It Important? 10

far, the strategic elements in Alibaba’s profit formula have delivered far superior performance compared to
the strategic elements in Amazon’s profit formula. Alibaba reported fiscal year 2020 operating profits of $12.9
billion on revenues of $72.9 billion (equal to an operating profit margin of 17.9 percent), whereas in calendar
year 2020, Amazon reported operating profit of $22.9 billion on sales revenues of $386.1 billion (equal to an
operating profit margin of 5.9 percent).

The nitty-gritty issue surrounding a company’s business model is whether it can execute its customer value
proposition profitably. Just because company managers have crafted a strategy for competing and otherwise
running various parts of the business does not automatically mean the strategy will lead to profitability—it may
or may not. Companies that have been in business for a while and are making at least reasonably attractive
profits have a “proven” business model—because there is hard revenue-cost evidence that their strategies
and approaches to operating can yield good profits. Companies that are in a startup mode or are losing money
have “questionable” business models; their strategies and operating approaches have yet to produce good
bottom-line results, thus raising doubts about their blueprint for making money and their viability as business
enterprises. Companies that operate in uncertain, volatile market environments often have business models
that quickly lose their effectiveness; for such companies to survive, they have to be adept at spotting the signs
of impending crisis early and then swiftly reinvent their business model and strategy.13

When a company pioneers a new and obviously successful business model approach, both its existing rivals
and new entrants usually quickly adopt imitative business models—the key features of a successful business
model are easy to identify and, often relatively easy to replicate.14 For example, over the past 15 years, the
business model for online retailing—a functional website, appealing product offerings, convenient checkout
and payment options, fast delivery (and perhaps even free shipping), no-hassle merchandise return procedures,
and cost-efficient order fulfillment and inventory management systems—has been successfully implemented
thousands of times all across the world.

WHAT MAKES A STRATEGY A WINNER?

Three tests can be applied to determine the merits of one strategy versus another and distinguish a winning
strategy from a so-so or flawed strategy:

1. The Fit Test: How well does the strategy fit the company’s situation? To qualify as a winner, a strategy
must be well matched to industry and competitive conditions, a company’s best market opportunities,
and other pertinent aspects of the business environment in which the company operates. At the same
time, it must be tailored to the company’s resources and competitive capabilities and be supported by
a complementary set of operating approaches (as
concerns supply chain management, research and CORE CONCEPT
development, production, sales and marketing, A winning strategy must fit the enterprise’s
and financial management). Unless a strategy external and internal situation, help build
exhibits good fit with both the external and sustainable competitive advantage, and improve
internal aspects of a company’s overall situation, company performance.
it is likely to be an underperformer and fall short
of producing good business results. Winning strategies also exhibit dynamic fit in the sense that they
evolve over time in a manner that maintains close and effective alignment with the company’s situation
even as external and internal conditions change.15

2. The Competitive Advantage Test: Is the strategy helping the company achieve a sustainable
competitive advantage? Winning strategies enable a company to achieve a competitive advantage
that is durable. The bigger and more durable the competitive edge that a strategy helps build, the
more powerful and appealing it is.

3. The Performance Test: Is the strategy producing good company performance? To be a winner, a
strategy must have resulted in not just substantially better company performance but also what is
clearly strong company performance. Two kinds of performance indicators tell the most about the
caliber of a company’s strategy: (1) competitive strength and market standing and (2) profitability and

Copyright © 2022 by Arthur A. Thompson. All rights reserved.

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 Chapter 1 • What Is Strategy and Why Is It Important? 11

financial strength. Gains in market share, improving competitiveness vis-à-vis rivals, above-average
profitability, and strong financial performance over the past 2-4 years are all signs of a winning strategy.

Strategies—either existing or proposed—that come up short on one or more of the tests are plainly less
appealing than strategies passing all three tests with flying colors. Failing grades on one or more tests should
prompt managers to make immediate changes in an existing strategy. Likewise, when picking and choosing
among alternative strategic actions, managers should be quick to discard alternatives that seem ill-suited to
a company’s internal and external situation or that offer little prospect of producing competitive advantage or
improved performance.

WHY CRAFTING AND EXECUTING STRATEGY

ARE IMPORTANT TASKS
Crafting and executing strategy are top-priority managerial tasks for two big reasons. First, there is a compelling
need for managers to proactively shape how the company’s business will be conducted. A clear and reasoned
strategy is management’s prescription for doing business,
its road map to competitive advantage, and its game plan for CORE CONCEPT
pleasing customers and improving financial performance. How well a company performs and the degree of
High-performing enterprises are nearly always the market success it achieves are directly attributable
product of astute, creative, and proactive strategy-making.
to the caliber of its strategy and the proficiency
Companies don’t get to the top of the industry rankings
with which the strategy is executed.
or stay there with flawed strategies, copycat strategies,
or with strategies built around timid actions to try and do
better.16 And only a handful of companies can boast of strategies that hit home runs in the marketplace due
to lucky breaks or the good fortune of having stumbled into the right market at the right time with the right
product—but the good fortunes of such companies are not long-lasting without subsequent success in crafting
a strategy that capitalizes on their luck and proves capable of long-term competitive success. So there can be
little argument that a company’s strategy matters—and matters a lot.

Second, even the best-conceived strategies will result in performance shortfalls if they are not executed
proficiently. Good day-in/day-out strategy execution and operating excellence are essential for a company to
perform close to its full potential. There can be no applause for managers who design a potentially brilliant
strategy and then stumble in their efforts to create an organization with the skills, resource capabilities,
operating practices, and culture needed to carry out the strategy in high-caliber fashion. Flawed and/or inept
implementation and execution of a company’s strategy are a surefire recipe for underachievement, both
financially and in competing against rivals.

Good Strategy + Good Strategy Execution = Good

Management
Crafting and executing strategy are thus core management tasks. Among all the things managers do, nothing
affects a company’s ultimate success or failure more fundamentally than how well its management team charts
the company’s direction, develops competitively effective strategic moves and business approaches, and
pursues what needs to be done internally to produce good day-in/day-out strategy execution and operating
excellence. Indeed, good strategy and good strategy execution are the most telling and trustworthy signs of
good management. Managers don’t deserve a gold star for designing a potentially brilliant strategy and then
failing to put the organizational means in place to carry it out in high-caliber fashion—weak implementation
and execution undermine the strategy’s potential and pave the way for shortfalls in customer satisfaction and
company performance. Competent execution of a mediocre strategy scarcely merits enthusiastic praise for
management’s efforts either.

The rationale for using the twin standards of good strategy making and good strategy execution to determine
whether a company is well-managed is therefore compelling: The better conceived a company’s strategy
and the more competently it is executed, the more likely the company will be a standout performer in the

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 Chapter 1 • What Is Strategy and Why Is It Important? 12

marketplace. In stark contrast, a company that has a muddled or flawed strategy and/or can’t seem to execute its
strategy competently is most likely a company whose financial performance is subpar, whose competitiveness
in the marketplace is suffering, whose executive leadership needs to be replaced, and whose business is at
long-term risk of being an underperformer unless it is better managed.

THE ROAD AHEAD

Throughout the chapters to come, the spotlight is trained on the foremost question in running a business
enterprise: What must managers do, and do well, to give a company its best shot for being attractively
profitable and successful in the marketplace? The answer that emerges, and that becomes the biggest lesson
of the course you are taking, is that doing a good job of managing inherently requires good strategic thinking
and good management of the strategy-making, strategy-executing process.

The content of the upcoming chapters focuses squarely on what every business student and aspiring manager
needs to know about crafting and executing strategy. We will explore what good strategic thinking entails,
describe the core concepts and tools of strategic analysis, and examine the ins and outs of crafting and
executing strategy. Then, in the accompanying strategy simulation exercise where you will run a company
in head-to-head competition with companies run by your classmates, you will have a golden learn-by-doing
opportunity to put the chapter content into practice and gain firsthand experience in actually crafting a strategy
for your company and figuring out how to execute it cost effectively and profitably. In the process, we hope to
convince you that first-rate capabilities in crafting and executing strategy are basic to managing successfully
and are skills every manager needs to possess.

As you tackle the chapters and undertake the activities of being a co-manager of your assigned company,
ponder the following observation by the essayist and poet Ralph Waldo Emerson: “Commerce is a game of skill
which many people play, but which few play well.” If the chapters and the experience of running your company
help you become a savvy player and better equip you to succeed in business, the time and energy you spend
here will indeed prove worthwhile.

KEY POINTS
The tasks of crafting and executing company strategies are the heart and soul of managing a business
enterprise and winning in the marketplace. A company’s strategy is the game plan management is using to
stake out a market position, conduct its operations, attract and please customers, compete successfully, and
achieve the desired performance targets. The central thrust of a company’s strategy is undertaking moves to
build and strengthen the company’s long-term competitive position and financial performance and, ideally, gain
a competitive advantage over rivals that then becomes a company’s ticket to above-average profitability. A
company’s strategy typically evolves and reforms over time, emerging from a blend of (1) company managers’
proactive and purposeful actions and (2) as-needed reactions to unanticipated developments and fresh market
conditions.

Closely related to the concept of strategy is the concept of a company’s business model. A company’s
business model is management’s story line for how and why the company’s product offerings and competitive
approaches will generate a revenue stream and have an associated cost structure that produces attractive
earnings and return on investment—in effect, a company’s business model sets forth the economic logic for
making money in a particular business, given the company’s current strategy.

A winning strategy fits the circumstances of a company’s external situation and its internal resource strengths
and competitive capabilities, builds competitive advantage, and boosts company performance.

Crafting and executing strategy are core management functions. How well a company performs and the degree
of market success it enjoys are directly attributable to the caliber of its strategy and the proficiency with which
the strategy is executed. No company’s management team deserves a grade of “good” for crafting a run-of-
the-mill strategy and/or for executing a strategy satisfactorily and, as a consequence, achieving no better than
adequate performance.

Copyright © 2022 by Arthur A. Thompson. All rights reserved.

Reproduction and distribution of the contents are expressly prohibited without the author’s written permission