Why do some companies succeed, whereas others fail? Strategic leadership is about how to most effectively manage a company’s strategy-making process to create competitive advantage. Strategy-making is the process by which managers select and implement a set of strategies that aim to achieve a competitive advantage. Strategy formulation is the task of selecting strategies, whereas strategy implementation is the task of putting strategies into action, which includes designing, delivering and supporting products; improving the efficiency and effectiveness of operations; and designing a company’s organizational structure, control systems, and culture.
This article seeks to explain how leaders can manage the strategy-making process by formulating and implementing strategies that enable a company to achieve a competitive advantage and superior performance. Moreover, you will learn how the strategy making process can go wrong, and what managers can do to make this process more effective. Strategic leadership is concerned with managing the strategy-making process to increase the performance of a company, thereby increasing the value of the enterprise to its owners, that is, its shareholders.
To increase shareholder value, managers must pursue strategies that increase the profitability of the company and ensure that profits grow. To do this, a company must be able to outperform its rivals; it must have a competitive advantage. Maximizing shareholder value is the ultimate goal of profit-making companies, for two reasons. First, shareholders provide a company with the risk capital that enables managers to buy the resources needed to produce and sell goods and services. Risk capital is capital that cannot be recovered if a company fails and goes bankrupt. Shareholders will not provide risk capital unless they believe that managers are committed to pursuing strategies that provide a good return on their capital investment. Second, shareholders are the legal owners of a corporation, and their shares therefore represent a claim on the profits generated by a company.
Thus, managers have an obligation to invest those profits in ways that maximize shareholder value. Managers must behave in a legal, ethical and socially responsible manner while working to maximize shareholder value. By shareholder value, I mean the returns that shareholders earn from purchasing shares in a company. These returns come from two sources: (a) Capital appreciation in the value of a company’s shares. (b) Dividend payments. One way of measuring the profitability of a company is by the return that it makes on the capital invested in the enterprise. The return on invested capital (ROIC) that a company earns is defined as its net profit over the capital invested in the firm (profit/capital invested). By net profit, I mean net income after tax. By capital, I mean the sum of money invested in the company: that is, stockholders’ equity plus debt owed to creditors. So defined, profitability is the result of how efficiently and effectively managers use the capital at their disposal to produce goods and services that satisfy customer needs.
A company that uses its capital efficiently and effectively makes a positive return on invested capital. The profit growth of a company can be measured by the increase in net profit over time. A company can grow its profits if it sells products in markets that are growing rapidly, gains market share from rivals, increases the amount it sells to existing customers, expands overseas, or diversifies profitably into new lines of business. Together, profitability and profit growth are the principal drivers of shareholder value. To both boost profitability and grow profits over time, managers must formulate and implement strategies that give their company a competitive advantage over rivals. Managers do not make strategic decisions in a competitive vacuum.
Their company is competing against other companies for customers. Competition is a rough-and-tumble process in which only the most efficient and effective companies win out. It is a race without an end. To maximize shareholder value, managers must formulate and implement strategies that enable their company to outperform rivals-that give it a competitive advantage. A company is said to have a competitive advantage over its rivals when its profitability is greater than the average profitability and profit growth of other companies competing for the same set of customers. The higher its profitability relative to rivals, the greater its competitive advantage. A company has a sustained competitive advantage when its strategies enable it to maintain above-average profitability for a number of years.
The key to understanding competitive advantage is appreciating how the different strategies managers pursue over time can create activities that fit together to make a company unique or different from its rivals and able to consistently outperform them. A business model is a manager’s conception of how the set of strategies their company pursues should work together as a congruent whole, enabling the company to gain a competitive advantage and achieve superior profitability and profit growth. In essence, a business model is a kind of mental model of how the various strategies and capital investments a company should fit together to generate above-average profitability and profit growth. A business model encompasses the totality of how a company will:
- Select its customers.
- Define and differentiate its product offerings.
- Create value for its customers.
- Acquire and keep customers.
- Produce goods or services.
- Lower costs.
- Deliver goods and services to the market.
- Organize activities within the company.
- Achieve and sustain a high level of profitability.
- Grow the business over time.
It is important to recognize that in addition to its business model and associated strategies, a company’s performance is also determined by the characteristics of the industry in which it competes. Different industries are characterized by different competitive conditions. In some industries, demand is growing rapidly, and in others it is contracting. Some industries might be beset by excess capacity and persistent price wars, others by strong demand and rising prices. In some, technological change might be revolutionizing competition; others may be characterized by stable technology.
In some industries, high profitability among incumbent companies might induce new companies to enter the industry, and these new entrants might subsequently depress prices and profits in the industry. In other industries, new entry might be difficult, and periods of high profitability might persist for a considerable time. Thus, the different competitive conditions prevailing in different industries may lead to differences in profitability and profit growth. For example, average profitability might be higher in some industries and lower in other industries because competitive conditions vary from industry to industry.
Managers are the linchpin in the strategy-making process. It is individual managers who must take responsibility for formulating strategies to attain a competitive advantage and for putting those strategies into effect. They must lead the strategy-making process. In most companies, there are two primary types of managers: general managers, who bear responsibility for the overall performance of the company or for one of its major self-contained subunits or divisions, and functional managers, who are responsible for supervising a particular function, that is, a task, activity, or operation, such as accounting, marketing, research and development (R&D), information technology or logistics. Put differently, general managers have profit and-loss responsibility for a product, a business or the company as a whole. A company is a collection of functions or departments that work together to bring a particular good or service to the market.
If a company provides several different kinds of goods or services, it often duplicates these functions and creates a series of self-contained divisions (each of which contains its own set of functions) to manage each different good or service. The general managers of these divisions then become responsible for their particular product line. The overriding concern of general managers is the success of the whole company and also the divisions under their direction; they are responsible for deciding how to create a competitive advantage and achieve high profitability with the resources and capital they have at their disposal.
We can now turn our attention to the process by which managers formulate and implement strategies. Many writers have emphasized that strategy is the outcome of a formal planning process and that top management play the most important role in this process. Although this view has some basis in reality, it is not the whole story. The formal strategic planning process has five main steps:
- Select the corporate mission and major corporate goals.
- Analyze the organization’s external competitive environment to identify opportunities and threats.
- Analyze the organization’s internal operating environment to identify the organization’s strengths and weaknesses.
- Select strategies that build on the organization’s strengths and correct its weaknesses in order to take advantage of external opportunities and counter external threats. These strategies should be consistent with the mission and major goals of the organization. They should be congruent and constitute a viable business model.
- Implement the strategies.
The planning model suggests that a company’s strategies are the result of a plan, that the strategic planning process is rational and highly structured and that top management orchestrates the process. Several scholars have criticized the formal planning model for three main reasons: the unpredictability of the real world, the role that lower-level managers can play in the strategic management process and the fact that many successful strategies are often the result of serendipity, not rational strategizing.
Effective strategy formulation and implementation is the key to generating a competitive advantage. In strategy formulation, an organization should focus on its strengths that propel it past its competitors, while managing its weaknesses to avoid adverse impact from competitors taking advantage of its limitations.