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Strategy formulation is vital to the well-being of a company or organization. There are two major
types of strategy: (1) corporate strategy, in which companies decide which line or lines of
business to engage in; and (2) business or competitive strategy, which sets the framework for
achieving success in a particular business. While business strategy often receives more attention
than corporate strategy, both forms of strategy involve planning, industry/market analysis, goal
setting, commitment of resources, and monitoring.

IMPORTANCE OF STRATEGY

The formulation of a sound strategy facilitates a number of actions and desired results that
would be difficult otherwise. A strategic plan, when communicated to all members of an
organization, provides employees with a clear vision of what the purposes and objectives of the
firm are. The formulation of strategy forces organizations to examine the prospect of change in
the foreseeable future and to prepare for change rather than to wait passively until market forces
compel it. Strategic formulation allows the firm to plan its capital budgeting. Companies have
limited funds to invest and must allocate capital funds where they will be most effective and
derive the highest returns on their investments.

On the other hand, a firm without a clear strategic plan gives its decision makers no direction
other than the maintenance of the status quo. The firm becomes purely reactive to external
pressures and less effective at dealing with change. In highly competitive markets, a firm without
a coherent strategy is likely to be outmaneuvered by its rivals and face declining market share or
even declining sales.

The formulation of sound strategy may be seen as having six important steps:

1. The company or organization must first choose the business or businesses in which it
wishes to engage—in other words, the corporate strategy.
2. The company should then articulate a "mission statement" consistent with its business
definition.
3. The company must develop strategic objectives or goals and set performance objectives
(e.g., at least 15 percent sales growth each year).
4. Based on its overall objectives and an analysis of both internal and external factors, the
company must create a specific business or competitive strategy that will fulfill its
corporate goals (e.g., pursuing a market niche strategy, being a low-cost, high-volume
producer).
5. The company then implements the business strategy by taking specific steps (e.g.,
lowering prices, forging partnerships, entering new distribution channels).
 6. Finally, the company needs to review its strategy's effectiveness, measure its own
performance, and possibly change its strategy by repeating some or all of the above steps.

DEFINING THE BUSINESS

While this would appear to be the easiest of the six steps listed above, the simplicity of this first
step is deceptive. Businesses must be defined in terms of their customers. Without customers,
there is no business. They are a firm's only real source of revenue and, hence, of power.
Successful businesses are those that create profitable customers. With this in mind, it makes
sense to define any business in terms of its customers. Some companies achieve success by
concentrating on product development, product quality, efficient production, and other product
related functions. However, it is important to remember that the success of these companies is
entirely dependent upon customers valuing a firm's products above others, or appreciating the
lower prices provided through the firm's abilities to produce at lower costs. One cannot assume
that customers always want to pay less for their goods and services. In the markets for luxury
goods like perfumes, for example, few companies have been successful in pursuing the strategy of
being the low-cost supplier, whereas in other markets this is a highly coveted industry status.

INDUSTRY DEFINITION BY END BENEFIT.

Business scholars have long urged corporate leaders to define their businesses broadly and in
terms of the end benefits their customers receive. Hence, oil companies should not view
themselves as being in the "oil business," but in terms of the broader category of "energy," when
attempting to market oil as a fuel. Automobile drivers don't necessarily have a strong preference
for exactly what fuels their vehicle. If ethanol could power their vehicle as conveniently as
gasoline, the consumer would have little preference between the two systems. If ethanol were
more convenient and less expensive than gasoline, consumers would buy ethanol and not
gasoline. Drivers aren't buying gasoline for its own sake when they visit a service station; rather,
what they are buying is energy to facilitate transportation.

An example of an effectively broad industry definition comes from Charles Revson (1906-1975),
founder of Revlon cosmetics, who often said he was in the business of selling "the promise of
hope." This insightful business definition led Revson to concentrate his efforts on meticulously
creating advertising depicting feminine images that were unrealistic to the vast majority of his
customers, yet were perfectly consistent with their deepest hopes for themselves. Lotteries
operate on the same principles. Few people expect to win, so the benefit is the hope of winning.
Hope can be a very profitable business to be in even if it is difficult to imagine as an industry.

DEFINITION BY CUSTOMERS SERVED.

Many successful companies have defined themselves in terms of their customers. A general store
in a remote area would do well to define its business as serving the customers in its trading area.
While such a business definition might lead the firm in directions that would be at the whim of
the local clientele, that business should remain profitable as long as customers are happy. An
example of such a business is L.L. Bean, which was started when Leon L. Bean developed a
superior hunting boot well suited for his native Maine and sold it through the mail to a mailing
list of Maine residents who had purchased hunting licenses. The mail order company grew by
first serving the needs of hunters and later by expanding the concept to all wilderness activities.
While this might seem to be a definition based upon an activity, careful examination of L.L. Bean
shows that the firm has identified a psychographic market segment to which it continually caters.
Many of its buyers really don't care for wilderness sports as much as they simply identify with the
targeted market segment and wish to buy products that conform to the segment's norms.

DEFINITION BY TECHNOLOGY.

Genentech Inc. is a firm engaged in the development of genetic research and biotechnology for
pharmaceuticals: it has defined itself as being in the biotech business. Business definition by
technology leads to a very tumultuous corporate existence, as the business enterprise turns
direction every time there's a new invention.

STRATEGIC MISSION

The strategic mission of an organization embodies a long-term view of what sort of organization
it wishes to become. The value to management of having a lucid mission statement—the second
step in strategy formulation—can be in rendering tangible the firm's long-term course and in
guiding decisions toward a rational design. Among the elements that are key to a good mission
statement are a statement of corporate values and philosophy, a statement of the scope and
purpose of the business, an acknowledgement of special competencies, and an articulation of the
corporate vision for its future.

STRATEGIC OBJECTIVES

Clearly stated strategic objectives, the third step of strategy formulation, outline the position in
the marketplace that the firm seeks. Performance targets state the measurable milestones that
the firm needs to reach or obtain to achieve its strategic objectives.

Some strategic objectives relate to the positioning of goods and services in the competitive
marketplace while others concern the structure of the company itself and how it plans to produce
goods or manage its operations. Typical strategic objectives involve profitability, market share,
return on investment, technological achievement, customer service level, revenue size, and
diversification.

In order to make strategic planning work, the goals, missions, objectives, performance targets, or
other hopes of top management must somehow be made real by others in more distant locations
down the organizational chart. Merely communicating to each member of the business the vision
that top management has for the firm is not sufficient. Strategic objectives and performance
targets should penetrate every corner of the organizational chart. There should be a hierarchy of
strategic formulation starting with the highest levels of the firm, from which it is consistently
translated from level to level so that each department knows what its contribution to the overall
mission of the firm is to be. This process should end with each individual in the firm having
strategic objectives and performance targets tailored to their specific role in the firm.

ORGANIZATION-WIDE STRATEGY LEVEL.

This is top management's plan for achieving its aims. These strategies are for the entire
organization and should not concern the specific affairs of individual business units.

Organization-wide strategy requires schemes for overseeing the extent and combinations of
companies' assorted actions in order to achieve a superior corporate performance. When
numerous activities are being managed simultaneously, there are interactive effects in managing
the group of activities as a whole. Such a group of activities is often referred to as the "business
portfolio." Proper management of the business portfolio demands actions and decisions about
how and when the firm should enter new ventures and what areas the firm needs to exit. Further,
in all management, timing is crucial. Top management needs to set the timetable for business
entry, exit, growth, and downsizing. Often a sound strategy goes awry when management
attempts to move too quickly, too slowly, or just fails to set any timetable for action allowing for
little temporal coordination of the firm's efforts. Further, organization-wide strategy should
address the balance of resources across the firm's various activities. These resources need to be
allocated to direct the company's activities toward the strategic objectives of the organization.
Through these activities at the corporate-wide level, decisions about balancing business risks can
maximize security for the firm.

BUSINESS STRATEGY

The fourth step in strategy formulation requires developing the business or competitive strategy.
Business strategy refers to the strategy used in directing one coherent business unit or product
line. The most crucial question business strategy should address is how the unit plans to be
competitive within its specific business market. Important logistical issues to consider include (1)
what role each of the functional areas within the business unit will play in creating this
competitive advantage in the marketplace; (2) what the potential responses are to prospective
changes in marketplace; and (3) how to allocate the business unit's resources between its various
divisions.

The overall competitive strategy should take into account three main factors: (1) the status,
make-up, and prognosis of the industry as a whole and its market(s); (2) the firm's position
relative to its competitors; and (3) internal factors at the firm, such as particular strengths and
weaknesses.

INDUSTRY ANALYSIS.

An industry or market analysis should consider the structure of the industry, the forces
compelling change within the industry, the cost and price economics of the industry, elements
critical to success in the industry, and imminent problems and issues in the industry.

A review of the industry's structure should evaluate factors such as these:

 the size of the total market

 the growth rate of the market
 profitability of the firms in the industry
 whether the industry is producing at capacity or there is excess capacity already in place
 the entry barriers to the industry
 whether the industry's products are commodity goods or highly unique

Change in an industry may occur along several lines, and the direction of change often has major
implications for the competitive strategy. In an obvious example, if a manufacturing industry is
facing in the medium term a massive technological overhaul due to phase-in of environmental
regulations, it would probably make little sense to bring a major new factory on line using the
older technology, even if for the moment it is still more widely used. Other noteworthy industry
changes to consider include what stage of development the industry and its market are at
(developing, mature, declining), what technological advances could impact the industry, what
regulatory changes are new or on the horizon, and whether there are major patents about to
expire that will allow cheaper entry into the market.

It is also important to examine in detail the economics of doing business in a particular industry.
One area of particular concern is the cost structure. For instance, industries characterized by a
high percentage of fixed costs are subject to extreme price wars during competitive times in the
market. Airlines are an example of a high-fixed-cost industry. Industries with high variable costs
tend to have smaller swings in their pricing structure. Cost structure also has implications for
capital and cash flow requirements, as well as for the overall entry barriers to participating in the
industry.

Production costs tend to decline over time in proportion to the total quantity of goods produced.
This is mainly due to two factors: learning and experience. Each has its own curve, the "learning
curve" and the "experience curve." While each of these effects might be diagnosed separately, the
end effect of both may be the same: the firm that produces the most goods in the industry tends
to have the lowest cost of production in the long term. All things being equal, this will give that
firm the long term cost advantage in the industry for the life of the product.

In a typical scenario, being the low-cost producer allows the firm to receive not only the greatest
margin on its products when all firms in the market participate in an established price structure,
but when price competition arises the low-cost producer can make a profit or break even on its
goods, while its competitors lose money. This is a key strategic advantage. This is why many
firms during the development of a new and potentially large long-term market will forgo a
profitable, small, prestige niche strategy for a less profitable market penetration strategy that
demands heavy investment and expansion of production. This second strategy can yield a long-
term advantage in the industry by allowing the firm to gain from the learning and experience
effects. Competitors later may not be able to catch up since they lack the cumulative production
experience and assets of the pioneer in the industry.

One alternative to the low-cost strategy is a highvalue strategy, in which customers pay more but
also expect to receive a product or service somehow better than that offered by the low-cost
supplier. The improvement may be tangible in durability and features, or it may be an appeal to
status, image, or lifestyle that makes the product or service more compelling to some consumers.

However, even industry leaders must guard against complacency; they might be on top in the
traditional market paradigm, but there may be a new paradigm emerging that will make them
obsolete if they fail to change. The accumulation of learning and experience does little good if
these assets are directed at the wrong vision of the market. This has strategic implications not
only for the market leader, but also its competitors, who may be able to benefit from the leader's
slow rate of change. A real-life example was the rise of Wal-Mart Stores, Inc. from a regional
discount chain to the world's largest retailer. Arguably its older competitors like Kmart had more
experience, but they failed to adapt to the market changes, technologies, and aggressive
management practices that helped propel Wal-Mart to market dominance. Wal-Mart embodied a
new paradigm in general consumer merchandise retailing, a model that the former market
leaders have since tried to emulate.

COMPETITORS.
A fundamental part of developing a business strategy is to understand in detail who the main
competitors are and where their strengths and weaknesses lie. Competitors can be analyzed by
the type of goods they produce, their price, markets served, or channels of distribution used.
Many industries have clear niching, with each firm or group of firms avoiding direct competition
through some combiniation of product differentiation or market segmentation. Other industries
are characterized by large-scale head-on competition. Coca-Cola and Pepsi, in the soft drink
industry, are a highly visible example.

Not all future competition originates from present competitors, however. New market entrants
are most often found lurking on the sidelines of the firm. For example, suppliers are often
looking to forward integrate into an industry. Suppliers of the raw materials that go into a
product may have a competitive cost advantage through such vertical integration. Suppliers are
often motivated in such moves by the assurance of having a guaranteed market for their output.

On the flip side, customers may decide to backward integrate into business. Customers
considering backward integration usually first attempt to establish their own "private labeled"
product prior to integration. When customers put considerable time and effort into their private
label version of a product, it may well be a sign of a growing intent to backward integrate. The
notion of private label is most associated with retailing, where, for example, grocery stores have
house labels, but may or may not actually manufacture the products bearing their labels.
However, similar practices exist in many other lines of business.

Firms that produce either substitutes for a product or complementary goods to a product may
also be a competitor. These firms have experience in the market, and a competitor's product
niche in the market represents a simple product line extension for their firm. Often the threat of
competitive retaliation into these firms' product areas is useful in deterring such moves.

Barriers to market entry are often responsible for setting the level of competition in an industry.
Historically, retail has tended to be a competitive industry due to the relatively low costs of entry
into the market (although this has changed somewhat as large chains consolidate and have
significant price and marketing advantages over smaller competitors). But compared to
manufacturing heavy industrial goods, retail still has relatively few barriers. American auto
manufacturers probably worry very little about other American firms entering the market of
passenger automobiles, because both the financial and regulatory barriers to entry are far too
high. Not all barriers are financial. Drug firms enjoy oligopoly status due to their abilities to
interface with the U.S. Food and Drug Administration in getting new drugs approved. New firms
would have great difficulty in developing the same working relationships. Military suppliers also
enjoy an oligopoly status due to political barriers to entering the market. Each firm must analyze
what factors keep its competitors at bay when assessing the potential for others to want to share
in their profits.

IMPLEMENTING STRATEGIES

A strategy is of course only as good as its implementation. A company may have an impressive
strategy for conquering the market, but if it fails to take the right steps the strategy is
meaningless. The means of implementing strategies are called tactics. The tactical execution,
while crucial to the success of any strategy, is not a traditional part of the formulation of that
strategy. However, many firms have been successful in discovering successful tactics and
building their strategies about "what works." The implementation experience, whether favorable
or unfavorable, also directly informs the strategy revision process or any new strategies, as the
company will take into account its successes and failures when choosing future paths.

MONITORING AND ASSESSMENT

Strategy formulation should be done on a regular basis, as often as required by changes in the
industry. Firms need to track the company's progress, or lack thereof, on the key goals and
objectives outlined in the strategic plan. The company must be objective and flexible enough to
realize whether the strategy is no longer appropriate as it was first conceived, and whether it
needs revision or replacement. In other cases, the strategy itself may be fine, but the
communication of the strategy to employees has been inadequate or the specific steps to
implementation haven't worked out as planned. This evaluation and feedback of the strategy
formulation, the final step, provides the foundation for successful future strategy formulation.

Read more: Strategy Formulation - benefits

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