© ICSA, 2012 Page 1 of 18

Strategy in Practice June 2012

Suggested answers and examiner’s comments Important notice When reading these answers, please note that they are not intended to be viewed as a definitive ‘model’ answer, as in many instances there are several possible answers/approaches to a question. These answers indicate a range of appropriate content that could have been provided in answer to the questions. They may be a different length or format to the answers expected from candidates in the examination. Examiner’s general comments Overall, the performance for the June 2012 session of Strategy in Practice was similar to the November 2011 session. The answers that scored the highest marks focused on the question, dealt with the key issues that were raised, and contained references and examples to support all the points made, whichever question was answered. It is worth re-iterating again that the Strategy in Practice paper is not divided into sections and four questions can be chosen from any of the six questions. However, there are two groups of questions – questions 1 to 4 are based on the pre-released case study and questions 5 and 6 are more general in character and may require application to an organisation of your choice, exploration of information given in the question, or a critical review of material from the syllabus. So a key point is that candidates will always have to answer at least two questions, and may answer all the questions, based on the case study. This is an important part of candidates’ preparation for the examination. A pre-released case study gives candidates time to consider and reflect on the strategic issues it raises for the organisation, research the context and subsequently to apply this in answer to the examination questions. It is important to repeat that in many answers to questions 1 to 4, candidates made insufficient use of the facts of the case study and referred to them only in passing. It was evident from the answers provided that few candidates had undertaken any research into the sector and its issues. However, for the first time, it was clear that some candidates had done this and it was reflected in their performance. Another key point noted for previous examination sessions is that, in preparing for the examination, it is important to use the models and frameworks from the syllabus to take an analytical view of your own organisation, the case organisation, and others, so that you are able to use the information in the examination. This is something that can be done beforehand in preparing for the examination itself.

© ICSA, 2012 Page 2 of 18

Case Study

HomeCo HomeCo, a home-furnishing chain, was started in 1951 and became a highly successful global business with a unique retailing concept. By 2007, it had 255 stores in Europe, Asia, and North America, which attracted around 390 million shoppers each year. At that time, HomeCo accounted for 5 - 10% of the furniture market in each country in which it operated, but CEO Andrea Hague argued that awareness of their brand was much bigger than the size of the company: “That’s because HomeCo is far more than a furniture merchant. It sells a lifestyle that customers around the world embrace as a signal that they have good taste and recognise value. If it wasn’t for HomeCo, most people would have no access to affordable contemporary design.” In 2006/7 revenues rose 15%, to £12.7 billion. As the company was (and still is) privately owned, HomeCo’s profits could only be estimated at £1.2 billion. HomeCo’s approach had been to maintain these profits while cutting prices steadily. Its operating margins of approximately 10% were historically among the best in home furnishing. The company was also regarded ‘best-in-class’ for its logistics and had changed its approach to use large centrally-organised regional distribution centres rather than allowing this to be managed by individual countries. What seemed to enthral HomeCo shoppers was the store visit, an experience that was similar everywhere. The distinct red and white buildings averaged 300,000 square feet, the size of over three football pitches. They were sited in prime, edge of town locations and were easily accessible. The number of items (7,000, ranging from kitchen cabinets to candles) was an advantage. “Others offer affordable furniture,” said a retail consultant in 2003, “but there’s no one else who offers the whole concept in a single place.” Some customers tended to think of the store visit as an outing rather than a chore. The consultant reported that HomeCo practised “a form of gentle coercion” to keep customers in store as long as possible. “They have a restaurant in the centre of the store and a series of room displays showing off the products to inspire them to spend more. All large items are flat-packed, which not only saves HomeCo millions in shipping costs from suppliers but also enables shoppers to transport their goods home for assembly: another saving for both parties.” The customer group targeted by HomeCo tended to share buying habits, and spending per customer was also similar in each country in which it operated. According to HomeCo, the figure in Russia was £80 per store visit: exactly the same as the more affluent Netherlands. Enthusiasm amongst staff over the years stemmed from the founder Jan Zuiderant, who started the company from a shed on his family’s farm in the Netherlands. His belief in creating ‘great living for many’ is enshrined in his almost evangelical 1980 tract ‘A Furniture Retailer’s Bible’, which contained phrases such as “wasting resources is a mortal sin” and “it is our duty to expand”. The pamphlet was given to all employees on the day they started with the company. Staff turnover was traditionally 30% lower than the industry average. Zuiderant’s ideas defined HomeCo culture and continue to do so today. One element was ‘egalitarianism’, the other ‘value’. Every HomeCo executive worked on the shop floor or tills for one week each year. At the entrance to HomeCo’s main offices, a large screen tracked weekly sales growth, named the best-performing country markets, and identified the best-selling furniture. The clear message has always been: cut prices. At the far end of the foyer there used to be a row of the best-selling sofas, displaying models from 2000 to 2007 with their price tags. The 2006 price was 50% cheaper than the model from 2000. Indeed, HomeCo aimed to lower prices across its range by 2% to 3% each year. Frugality was deeply ingrained. All managers flew economy and one recalled that, while flying with Zuiderant, the boss handed him a voucher for reduced price car hire from an in-flight magazine. This cost obsession fused with the design culture. No design found its way into the showroom if it could not be made affordable. HomeCo replaced a third of its product line every year. To achieve that goal, the company’s 12 full-time designers, along with 80 freelancers, worked in

© ICSA, 2012 Page 3 of 18

project teams with in-house production and suppliers to bring the products to market. Simplicity was a tenet of design that helped to keep costs down, and with a network of 1,300 suppliers in 53 countries HomeCo worked hard to find the right manufacturer for the right product. Innovation of new products was, and still is, centred in a specialised unit in the Netherlands. The suppliers and designers also customised some HomeCo products for local markets. In China, the 250,000 plastic placemats HomeCo produced to commemorate the year of the rooster sold out in three weeks. Five years ago, commentators started to ask whether the company could continue to thrive. To keep growing, HomeCo needed to accelerate new store openings. 25 new outlets were planned in each financial year to 2011/12. HomeCo was focussing on the US as key to expansion. However, HomeCo had stumbled badly once before. Entry into Japan 30 years ago was a disaster, as Japanese customers wanted high quality and great materials, not low prices and chipboard. Andrea Hague was also keen to boost HomeCo’s profile in the BRIC countries (‘Brazil, Russia, India and China’). The company was already popular in Russia and China (worth £60m in sales in 2006/7). But in India and Brazil, Andrea Hague had believed there were many opportunities. The goal was 60 outlets in these countries by 2012. So far, things have not gone well. The last five years have been difficult. Only a third of the new stores that were planned have been opened. Customer response has been poor. Sofas were the wrong colours, curtains were not the right size, and kitchen units did not suit the preferred appliances used in each country. Established markets have been particularly sluggish. The recession has not helped. HomeCo has seen more competition than ever in Europe. The competing ‘Maison’ chain recruited a top designer and launched a range of low-priced furnishings in October 2010. Another competitor, ‘Hmart’, has been collaborating with a number of designers and launched its own quality furniture line made out of natural materials but at affordable prices. Maison and Hmart both rely heavily on online sales, which allow purchasers to ‘design their own’ products by adding specific features. They also offer free delivery. HomeCo has lost market share to both, and industry commentators have pointed to the competitors’ more contemporary products. Customer visits to HomeCo have reduced markedly in number in all areas. Some have criticised HomeCo for its long queues and exasperating assembly experiences for furniture that does not last long. Customers no longer want to give half a day to buying a piece of furniture. It is increasingly difficult to find sites in some European countries and communities are not as keen as they once were to have a furniture warehouse generating lots of traffic in the neighbourhood. Buying online is not easy and delivery is expensive. Some industry commentators have pointed out HomeCo has been slow to exploit e-commerce. Perhaps a bigger issue is what has happened inside HomeCo. “The great challenge of any organisation as it becomes larger and more diverse is how to keep the core values alive”, says one Business School professor. HomeCo is still run by managers who were trained and groomed by Zuiderant (who, at 84 years old, has now retired). Andrea Hague, one of the few outsiders at a senior level, has recently announced that she is to leave the company. Other commentators have raised concerns about “failure to keep pace” and “losing direction”.

© ICSA, 2012 Page 4 of 18

Questions Questions 1 – 4, below, are connected to the pre-released case study. 1. (a) Using an appropriate framework, analyse HomeCo’s culture and its impact on the

company’s strategy. (15 marks)

Suggested answer A good place to start this question was with a definition of culture, before going on to apply the chosen framework, looking at examples from the case study, and making the link with strategy. One useful definition of culture is ‘the collection of traditions, values, policies, beliefs, and attitudes that constitute a pervasive context for everything we do and think in an organisation’ (McLean and Marshall, 1993). Culture is reinforced through the system of rites and rituals, patterns of communication, the informal organisation and expected patterns of behaviour. Candidates had an option about which framework to use. The most likely and most useful were Schein’s framework or Johnson and Scholes’ cultural web. Schein (1985), for example, suggests a view of organisational culture based on distinguishing three levels of culture: artefacts, values and basic assumptions. Level 1: Artefacts Artefacts are surface manifestations and the most visible level of the culture – the constructed physical and social environment. This includes physical space and layout, the technological output, written and spoken language and the overt behaviour of group members. In the case study, this would include the branding of HomeCo’s distinctive red and yellow buildings, store layout, and the behaviour of staff. Level 2: Values Values and beliefs are the part of the conceptual process by which group members justify actions and behaviour. For example, in the HomeCo case, Zuiderant’s belief in creating ‘a better life for many’ is enshrined in his 1980 tract ‘A Furniture Retailer’s Bible’. This contains phrases such as ‘wasting resources is a mortal sin’ and ‘it is our duty to expand’. The pamphlet is given to all employees the day they start. Level 3: Basic underlying assumptions Basic assumptions are implicit assumptions that guide behaviour and determine how group members perceive, think and feel about things. Schein suggests that the basic assumptions are the essence – what culture really is, and values and behaviours are observed manifestations of this cultural essence. This is akin to Johnson and Scholes’ paradigm. In the HomeCo case, we have the example of the frugality encouraged by Zuiderant and his car hire voucher. The link to strategy here is that keeping cost down helps the business in its chosen strategic objective of seeking to continually reduce prices. An important point for candidates to acknowledge in answers was that culture is a descriptive term concerned with how employees and other stakeholders perceive the characteristics of an organisation. For example, does it reward innovation, does it stifle initiative and does it support the structure? Here, alignment between culture and strategy is key. Credit was also given for noting the significance of national differences in culture, particular with an international/global business such as HomeCo.

© ICSA, 2012 Page 5 of 18

Examiner’s comments This was a popular question. Most candidates offered an appropriate definition but fewer developed this to explain its significance. In the main, Schein’s framework or the cultural web were used for the analysis but the link to strategy was not always made clear. Some candidates showed the model diagrammatically and this could have been annotated with the key examples from the case study. (b) Explain how strategic drift may have become a problem for HomeCo.

(10 marks) Suggested answer Candidates needed to start by defining strategic drift before going on to explain the issues involved for HomeCo. Strategic drift is the tendency for strategies to develop incrementally on the basis of historical and cultural influences, but failing to keep pace with a changing environment. The reasons for, and consequences of, strategic drift are important as it helps explain why organisations such as HomeCo often ‘run out of steam’. Organisational strategies tend to change gradually, sometimes on the basis of what the organisation has done in the past, especially if that has been successful. It is useful to explain this using a diagram such as the one below.

In successful businesses such as HomeCo, there are usually long periods of relative continuity during which established strategy remains largely unchanged or changes very incrementally. There may be good reason for this; the environment could be changing gradually and the organisation is simply keeping in line with those changes through incremental change. Problems arise as there may be a natural unwillingness by managers to change a strategy significantly if it has been successful in the past, especially if it is built on capabilities that have been shown to be the basis of competitive advantage. HomeCo’s success has been built in this way and, interestingly, the company has had problems when moving into new locations such as Japan and the USA. The challenge for managers, however, is how long and to what extent relying on incremental change and building on the past, is sufficient. This is the start of strategic drift. Whilst an organisation’s strategy may continue to change incrementally, it may not change in line with the environment. Phase 2, shown in the above diagram, shows environmental change accelerating but it is not sudden. For HomeCo, there were growing threats from competitors and some reluctance to embrace e-retailing. However, these changes had been taking place for many years. The problem that gives rise to strategic

© ICSA, 2012 Page 6 of 18

drift is whether the organisation is not keeping pace with these changes. If strategic drift continues, there may be a downturn in financial performance or a loss in market share. It appears that HomeCo may be in this position. If the company is in strategic drift, the model suggests that a period of flux may be triggered by the downturn in performance. Strategies may change but in no very clear direction. There may also be management changes, often at the very top, as the organisation comes under pressure from its stakeholders, not least shareholders. This could happen at HomeCo if Zuiderant finally withdraws completely. There may be internal rivalry as to which strategy to follow, quite likely based on differences of opinion as to whether future strategy should be based on historic capabilities or whether those capabilities are becoming redundant. The outcome will be one of three possibilities: the organisation may die; it may get taken over by another organisation; or it may go through a period of transformational change. This may involve multiple changes related to strategy such as a change in products or market focus, changes of capabilities on which the strategy is based, changes in the top management and perhaps the way the organisation is structured. Transformational change does not take place frequently in organisations and is usually the result of a major downturn in performance. The key time is in phase 2 when the organisation is beginning to drift. The problem is that drift is not easy to see before performance suffers. As Johnson et al (2008) say: ‘…in understanding the strategic position of an organisation so as to avoid the damaging effects of strategic drift, it is vital to take seriously the extent to which historical tendencies in strategy development tend to persist in the cultural fabric of organisations.’ This is the vital link between culture and strategy and as the direct links with Zuiderant disappear, the culture may start to fade. Examiner’s comments Most candidates offered an appropriate definition in answers to part (b). Weaker answers did not apply the Johnson and Scholes model (or another) of strategic drift to the case study.

© ICSA, 2012 Page 7 of 18

2. Review how HomeCo’s strategic capabilities have secured its advantage over competitors and why this may have changed in the last five years. (25 marks)

Suggested answer This question required candidates to make a clear link between strategic capability and competitive advantage. The key issue that needed to be addressed was how strategic capabilities provide competitive advantage in ways that can be sustained over time. Having capabilities that are different from other organisations is not, of itself, a basis of competitive advantage. Strategic capabilities are the resources and competences of an organisation needed for it to survive and prosper. Whereas in more stable conditions competitive advantage might be achieved by building capabilities that may be durable over time, in more dynamic conditions competitive advantage requires the building of capacity to change, innovate and learn – to build dynamic capabilities. Johnson et al (2008) argue that capabilities for achieving and sustaining competitive advantage are characterised by rarity, non-substitutability, and inimitability: Rarity Competitive advantage might be achieved if a competitor possesses a unique or rare capability. This could take the form of unique resources. For example, a powerful brand such as HomeCo’s and their retail stores have prime locations. Unique resources may be intellectual capital, particularly talented individuals such as Zuiderant. Rarity depends on who owns the competence and how easily transferable it is. For example, individuals may leave or join competitors and such a resource may be a fragile basis of advantage. Rarity could be temporary. If an organisation is successful on the basis of a unique set of competences, then competitors will seek to imitate or obtain those competences. There is a danger that rare capabilities may also become rigid and difficult to change. Managers may be so wedded to these bases of success that they perceive them as strengths of the organisation and ‘invent’ customer values around them. This may be the case in HomeCo and the way it is wedded to its stores as an outlet and in not exploiting the web. Substitutability An organisation’s competitive advantage may not be sustainable and be at risk from substitution. Substitution could take two different forms: product or service substitution, or competence substitution. Internet booksellers such as Amazon compete as substitutes for bricks-and-mortar booksellers such as W H Smith. Online home retailers may challenge HomeCo. The result is that resources such as their premier retail locations become less valuable. Inimitability Advantage is likely to be determined by the way in which resources are deployed to create competences in the organisation’s activities. Strategic capabilities are likely to be the skills and abilities to link activities or processes through which resources are deployed so as to achieve competitive advantage. In order to achieve this advantage, core competences therefore need to be difficult for competitors to imitate – or inimitable. The three main reasons are:

Complexity – The core competences of an organisation may be difficult to imitate because they are complex. This may be to do with internal linkages: the ability to link activities and processes that, together, deliver customer value. The HomeCo logistics and new product design processes provide an example from the case.

Culture and history – Core competences may become embedded in an organisation’s culture so coordination between various activities occurs ‘naturally’ because people know

© ICSA, 2012 Page 8 of 18

their part in the wider picture or it is simply ‘taken for granted’ The frugality referred to in the case study would be an example here.

Causal ambiguity – Another reason why competences might be difficult to imitate is that competitors find it difficult to discern the causes and effects underpinning an organisation’s advantage. For example, what is the root of HomeCo’s successful strategy – logistics, the stores or product design? You can study it and draw up a list of possible factors, but it is a complex process that is hard to understand and would be hard to imitate. Its strategy is now really ‘the HomeCo way’ of doing business. In other words, it became ingrained in the organisational culture. This is the key factor that makes a strategy difficult to imitate and creates strategic capability.

Candidates might also have answered this question by looking first at the notion of unique resources and core competences before, making the points about inimitability and deployment. Good answers also followed this with other approaches. Candidates could, for example, use one of the ways of diagnosing strategic capability such as the value chain (Porter, 1985), which describes the categories of activities within and around the organisation that together create the offering. This could have applied to the case study by analysing the support and primary activities. It would also have been relevant to consider the value network – the set of inter-organisational links and relationships necessary to create HomeCo’s products and services. The question also asked candidates to review why things may have changed in the last few years. This meant returning to the points in the introduction about durability over time. If in more dynamic conditions, competitive advantage requires the building of capacity to change, innovate and learn, then it could be that HomeCo has not succeeded or its capability in this area has reduced. Candidates might have pointed here to the problems associated with culture and drift raised in the previous question. They might also have pointed to the significance of failing to learn from previous experience of entering new markets, linking this to ideas or organisational learning and knowledge management. They could also have made a point about the leadership role in relation to strategy. Examiner’s comments This was another popular question but it was not always answered as well as it might have been. Weaker answers did not explore the capabilities for achieving and sustaining competitive advantage. Some answers included too much theory and did not use the facts of the case study. Some answers did not address the second part of the question about changes over the last five years.

© ICSA, 2012 Page 9 of 18

3. One commentator has mentioned the hybrid nature of HomeCo’s strategy.

(a) With reference to the case, discuss the nature of a hybrid strategy. (12 marks)

Suggested answer The answer needed to start with a clear definition. A hybrid or combination strategy seeks to achieve differentiation and low price relative to competitors simultaneously. The success of this strategy depends on the ability to deliver enhanced benefits to customers together with low prices whilst achieving sufficient margins for reinvestment to maintain and develop bases of differentiation. It is, in effect, the strategy HomeCo is following. The hybrid strategy can be advantageous when:

Greater volumes can be achieved than competitors so that margins may still be better because of a low-cost base. HomeCo is seeking to move this way although it has a relatively low market share in some areas at the moment.

Cost reductions are available outside its differentiated activities. For example, HomeCo has concentrated on building differentiation on the basis of its marketing, product range, logistics and store operations, but low customer expectations on service levels allow cost reduction because customers are prepared to transport and build the products.

It is used as an entry strategy in a market with established competitors. For example, in developing a global strategy a business may target a poorly run operation in a competitor’s portfolio of businesses in a geographical area and enter that market with a superior product at a lower price to establish a foothold from which it can move further.

Perhaps the primary benefit to firms that integrate low-cost and differentiation strategies is that it is generally harder for rivals to duplicate or imitate. Candidates might also have dealt with this question by reference to Bowman’s strategy clock (Bowman in Johnson et al.), which reviews options for competitive strategy in terms of perceived benefits of the product of service compared with price. The strength of this approach is that it allows for a comparison with other options and the extent to which the HomeCo strategy might be shifting – deliberately or otherwise.

Examiner’s comments Most answers to this question dealt with the essential elements of the hybrid strategy, which were required by the question. Weaker answers did not use facts from the case to discuss the nature of hybrid strategy.

(b) Explain the dangers to HomeCo of such a strategy. (13 marks)

Suggested answer The pitfalls of integrated overall cost leadership and differentiation include:

Becoming ‘stuck in the middle’ in failing to attain both strategies and becoming neither. Some companies may become ‘stuck in the middle’ if they try to attain both cost and differentiation advantages.

Underestimating the challenges and expenses associated with coordinating value-creating activities in the extended value chain. Successfully integrating activities across an organisation’s value chain with the value chain of suppliers and customers involves a

© ICSA, 2012 Page 10 of 18

significant investment in financial and human resources. Managers must not underestimate the expense of technology investment, managerial time and commitment, and the involvement and investment required by the organisation’s customers and suppliers. The company must be confident that it can generate a sufficient scale of operations and revenues to justify the expense. With developments over the last five years, there are signs that this is the case.

Miscalculating sources of revenue and profit pools in the industry. Organisations may fail to assess accurately sources of revenue and profits in their value chain. For example, politics could make managers manipulate the numbers to favour their area of operations. This would make them responsible for a greater proportion of the copany’s profits, thus improving their bargaining position.

In practice, the dangers are more difficult to manage:

A continuing danger is that the company fails to continue to be tough about the differentiating features and cost management. For HomeCo, there is a particular danger that when Zuiderant eventually leaves, the culture will start to flounder. Succession planning is the key to this.

Another danger is that the market moves away from this particular concept for reasons of changing incomes, demographics, lifestyles or simply tastes. There are signs of this in the case study with the preference for on-line shopping and a move back to quality in some markets.

The concept may fail to ‘travel’ as the company globalises – HomeCo hasalready made mistakes on that front. The key to this is good market research and some flexibility around the core concept.

HomeCo may also be outflanked by ‘low-price’ operators improving their product features and/or other companies entering that space.

At the other end, differentiators may improve their cost management.

In summary, however successful a company or a concept is, the company cannot sit on its laurels. Business history is littered with those that did. Examiner’s comments There were some very good answers to this question, where candidates demonstrated understanding of the difficulties and dangers of the hybrid approach. Weaker answers showed little or limited understanding of the nature of hybrid strategy and/or did not draw on the case study to explain them.

© ICSA, 2012 Page 11 of 18

4. Chandler (1962) argued that one of the fundamental rules of strategic management is that ‘unless structure follows strategy, inefficiency results.’

Other commentators have argued that the causality may be the other way and that structure may influence the strategies that are pursued. Required

(a) Briefly review the issues posed by these alternative views, using the HomeCo case.

(10 marks) Suggested answer Discussions of the relationship between strategy and structure usually imply that structure follows strategy. That is, the strategy that an organisation chooses dictates such structural elements as the division of tasks, the need for integration of activities, and authority relationships within the organisation. As stated in the question, Chandler (1962) argues that one of the fundamental rules of strategic management is that ‘unless structure follows strategy, inefficiency results.’ The design teams at HomeCo would be an example of this. However, an existing structure can also influence strategy formulation. For example, once a company’s structure is in place, it is very difficult and expensive to change. Managers at HomeCo, for example, may not be able to modify their approach to logistics without major disruption to a key plank of its strategy. That said, they appear to have managed such a change successfully. The key point is that the two are closely related. Amburgey and Dacin (1994) tested the relative impact of strategy and structure on each other by analysing the strategic and structural changes of more than 200 American corporations over 30 years. They found that moves towards decentralised structures were often followed by moves towards increasingly diversified strategies: here, structure was determining strategy. However, overall, increased diversification was twice as likely to be followed by structural decentralisation as the other way round. In other words, structure does follow strategy, but only most of the time. Mintzberg warns that a simple ‘design’ approach to strategy and structure can be misleading. Structure is not always easy to fix after the big strategic decisions have been made. Strategists should check to see that their existing structures are not constraining the kinds of strategies that they consider. Most organisations begin very small and either die or remain small. A business’ strategy and structure is likely to change as it increases in size, diversifies into new product markets, and expands its geographic scope. Examiner’s comments The best answers to this question looked at this question from ‘both ends’ and drew on the Amburgey and Dacin evidence. The weaker answers simply took Chandler’s view at face value and supported it uncritically. (b) Discuss the nature of transnational structure, with reference to HomeCo.

(15 marks) Suggested answer Transnational, or global, structures seek to obtain the best from the two extreme international strategies: the global strategy and the multi-domestic strategy. A global strategy would typically be supported by global divisions (for example, a worldwide furniture division and a worldwide logistics division); a multi-domestic strategy would be supported by local subsidiaries with a great deal of design, manufacturing and marketing autonomy for all products (for example, the local subsidiary responsible for its own (or at least tailoring) furniture design). International divisions refer to stand-alone divisions alongside the structures of the major home-based

© ICSA, 2012 Page 12 of 18

business, as is often the case when corporations start to internationalise. The transnational structure, however, attempts to achieve both high local responsiveness and high global coordination. In that sense, it resembles the matrix structural form but responds specifically to the challenge of internationalisation and tends to have more fixed responsibilities within its crosscutting dimensions. Bartlett and Ghoshal (1990) suggest that the transnational structure has the following characteristics:

Each national unit operates independently but is a source of ideas and capabilities for the whole corporation. For example, in HomeCo, the centre for innovation is in the Netherlands.

National units achieve greater economies of scale through specialisation on behalf of the whole corporation. HomeCo in Europe has replaced its web of small distribution units with a few specialised larger centres that export to other European countries.

The corporate centre manages this global network by first establishing the role of each business unit, then sustaining the systems, relationships and culture to make the network of business units operate effectively.

Deciding upon the most appropriate structure when a company has international operations depends on three primary factors: the extent of international expansion, the type of strategy (global, multi-domestic or transnational), and the degree of product diversity. The success of a transnational corporation is dependent on the ability to simultaneously achieve global competences, local responsiveness and organisation-wide innovation and learning. This requires clarity about boundaries, relationships and the roles that the various managers need to perform. For example, functional managers such as finance or product designers have a major responsibility for ensuring worldwide innovation and learning across the various parts of the organisation. This requires the skill to recognise and spread best practice across the organisation. So they must be able to scan the organisation for best practice, cross-pollinate this best practice and be the champion of innovations. Corporate (head office) managers integrate these other roles and responsibilities. Not only are they the leaders but they also facilitate the interplay between other parts of the organisation. For example, fostering the processes of innovation and knowledge creation and developing a strong management centre in the organisation. Examiner’s comments This was not a popular question and most answers did not show a clear understanding of transnational structure. Most answers discussed global or international structures in very general terms, without making clear the required distinctions.

© ICSA, 2012 Page 13 of 18

Questions 5 and 6, below, are not connected to the pre-released case study. 5. CableCo is a global communications business headquartered in the UK. It is parent to a

varied group of companies. Some are long-established and offer a full range of services such as telephone, cable TV, and internet provision for domestic users as well as data and communications services for large and small businesses in their geographical market.

Other companies in the group are newly created or acquired and are solely focused on business users, providing data and communications services, where the margins are higher and recent growth has been spectacular.

CableCo is often criticised by commentators for being unclear about its corporate role

and failing to add value.

Required

(a) Outline the nature of corporate parenting. (7 marks)

Suggested answer The corporate parent refers to the levels of management in an organisation above that of the business units, and therefore without direct interaction with buyers and competitors. The issue is the role of the corporate-level with regard to the individual business units that make up a diversified organisation’s portfolio. So the question is, given their detachment from the actual marketplace, how can corporate-level activities, decisions and resources add value to the actual businesses? Parents create value through management expertise. They improve plans and budgets and provide especially competent central functions such as legal, financial, human resource management, procurement and so on. Additionally, they help subsidiaries make wise choices in their own acquisitions and new internal development decisions. Such contributions often help business units to increase their revenues and profits substantially. There is some scepticism about the role of corporate-level strategy. The notion of corporate strategy assumes that corporations should own and control businesses in a range of markets or products. Williamson (1998) believes that diversified corporations should only exist in the presence of ‘market failures’. If markets worked well, there would be no need for business units to be coordinated through managerial structures. Business units could be independent, coordinating where necessary by simple transactions in the marketplace. The ‘invisible hand’ of the market could replace the ‘visible hand’ of managers at corporate headquarters. There would be no ‘corporate strategy’. So in the question scenario, it is possible that some of the businesses had reached a position where they would deliver increased value to shareholders as separately listed companies. Candidates might also have used examples from their own or other organisations to answer this question. (b) Suggest how portfolio analysis might help the strategic management of a multi-

business organisation such as CableCo. (18 marks) Suggested answer This question concerned how to achieve a good mix of businesses within a corporate portfolio such Cable Co. For example, which businesses should CableCo cultivate and which should it divest? It is necessary to look at:

© ICSA, 2012 Page 14 of 18

The balance of the portfolio, for example, in relation to its markets and the needs of the group.

The attractiveness of the business units in terms of how strong they are individually and how profitable their markets or industries are likely to be.

The fit that the business units have with each other in terms of potential synergies or the extent to which the corporate parent will be good at looking after them.

Portfolio analysis can he used to describe the current range of Strategic Business Units (SBUs) and to assess the ‘strength’ of the mix both historically and against future scenarios. One of the most common and long-standing ways of conceiving of the balance of a portfolio of businesses is the Boston Consulting Group (BCG) matrix. Here market share and market growth are critical variables for determining attractiveness and balance. High market share and high growth are attractive. However, the BCG matrix also warns that high growth demands heavy investment, for instance, to expand capacity or develop brand. There needs to be a balance within the portfolio, so that there are some low growth businesses that are making sufficient surplus to fund the investment needs of higher growth businesses.

Star is an SBU that has a high market share in a growing market. The SBU may be spending heavily to gain that share, but costs should be reducing over time and, it is to be hoped, at a rate faster than that of the competition.

Question mark (or ‘problem child’) is also in a growing market, but does not have a high market share. It may be necessary to spend heavily to increase market share, but if so, it is unlikely that the SBU is achieving sufficient cost reduction benefits to offset such investments.

Cash cow has a high market share in a mature market. Because growth is low and market conditions are more stable, the need for heavy marketing investment is less. But high relative market share means that the SBU should be able to maintain unit cost levels below those of competitors. The cash cow should then be a cash provider, perhaps to finance ‘question marks’.

Dog has a low share in static or declining markets and is thus the worst of all combinations. Dogs may be a cash drain and use up a disproportionate amount of company time and resources.

Some caution is needed with portfolio analysis. For example:

There can be practical difficulties in deciding what exactly ‘high’ and ‘low’ mean in a particular situation.

The analysis should be applied to strategic business units (i.e. a bundle of products or services and the associated market segments) not to whole markets.

Corporate management must develop the ability and devote the time to reviewing the role of each SBU in the overall mix of company activities. This is an important responsibility of the corporate centre. Some are sceptical of whether the corporate centre really does add value to the company through these processes of buying, selling, developing or running down individual units to keep the portfolio balanced. They suggest that the free market might allocate resources more effectively.

The original BCG analysis concentrated on the needs of a business to plan its cash flow requirements across its portfolio. So cash cows will be used to create the funds needed for innovation and the development of question marks and stars. However, little is said about the behavioural implications of such a strategy. For example, how does central management motivate the managers of cash cows, who see all their hard-earned surpluses being invested in other businesses?

© ICSA, 2012 Page 15 of 18

In many organisations the critical resource to be planned and balanced will not be cash, but innovative capacity. Question marks and stars are very demanding on these types of resource.

The position of dogs is often misunderstood. Certainly, there may be some products that need immediate deletion but even then there may be political difficulties if they are the brainchild of people with power within the organisation. Other dogs may have a useful place in the portfolio. They may be necessary to complete the product range and provide a credible presence in the market.

Examiner’s comments Question 5 was a fairly popular question. Weaker answers did not provide an explanation of corporate parenting in sufficient depth for part (a). Better answers provided examples from candidates’ own experience and also focused on the limitations of portfolio analysis. Candidates could have re-produced the BCG matrix diagrammatically for part (b), and many did.

© ICSA, 2012 Page 16 of 18

6. (a) Using an organisation with which you are familiar, critically review the way in which its governing body influences strategy.

(15 marks)

Suggested answer Answers to this question depended on the context of the organisations that were used as an example. It was key that an appropriate framework was used for evaluation or review in each case. Candidates might have used Garratt’s framework. Garratt (1996) quotes an ancient Chinese saying that ‘the fish rots from the head’. His point is that ultimately a strategy’s success or failure depends on the performance of its governing body or leadership team, which is ultimately accountable for both the choice and success of strategy. As board activities are made more and more transparent under national and international law, Garratt believes that there is a need for a transformation in the way the directors view their role and their capability. Some commentators argue that there is little confidence that the interests of shareholders or stakeholders (whether they be staff, customers, suppliers, local communities or the physical environment) are being looked after satisfactorily. They believe that this is because of the over-emphasis on managing or being a professional, and the under-emphasis on directing – showing the way ahead and giving leadership at the level of the board. A corporation needs effective management to keep its day-to-day operations running. But to ensure that it sustains itself in the long term it needs effective directing too. If this is not recognised by the board of directors, performance suffers. Garratt argues that there are two key issues here: (i) Directing not managing It is the board’s job to strike a balance between the external and internal pressures on the

organisation to ensure its survival. The board must give a clear direction to the business and create the climate in which its people can align and attune to that direction. It is the board’s job to ensure that members are committed to a common purpose, with similar values and behaviours, so that the organisation can function effectively and efficiently. There is a vast difference between ‘directing’ and ‘managing’ an organisation. Managing is a hands-on activity thriving on crises and action. On the operations side of an organisation it is a crucial role. Directing is essentially about showing the way ahead, giving leadership. It is thoughtful and reflective. Both managing and directing are necessary for a healthy enterprise. It is essential that the board learns how to cope with the difficult, messy uncertainty of these issues in rigorous and self-disciplined ways. A ‘directorial mindset’ is needed. But Garratt suggests that the dynamic balance between organisational efficiency and organisational effectiveness is not understood.

(ii) Handling four dynamic balances The basic system in which a board must operate can be defined by four opposing forces

that have to be balanced against each other. A key task of the board of directors, under the ultimate responsibility of the chair, is to create sufficient space to maintain a continuous overview of these:

Organisational effectiveness – The external, long-term perception in the customer’s mind of the products or services being desirable and good value for money.

Organisational efficiency – The internal, short-term focus on cost reduction and efficiency gain, just before it affects the customers’ perception of organisational effectiveness in a negative way.

Board performance – The external focus of the board on policy formulation in relation to the external ‘political’ environments; and on strategic thinking about the

© ICSA, 2012 Page 17 of 18

competitive positioning and broad resource allocation of the enterprise in relation to its policies.

Board conformance – The internal focus of the board on its performance to pre-set goals of accountability to its stakeholders and to its business performance through its people.

Each of these four forces has the potential to contradict each of the others and there are massive expectations demanding diversity, in terms of breadth and depth of experience, knowledge, attitudes and skills. Garratt resolves these dilemmas in terms of a set of board roles. Much of the work and concern of corporate governance is with conformance. This involves accountability to shareholders and other stakeholders, and the supervision of management. Performance involves driving the whole enterprise forward, allowing it to survive and grow by maintaining and developing its position. The strategic management process can be characterised as a combination of policy and strategic formulation.

As an alternative to the Garrat approach, candidates might also have stressed that there are two general options in how boards engage with strategy. This can be entirely delegated to management, with the board receiving and approving plans and decisions. Here, the stewardship role requires that purpose and strategy is not ‘captured’ by management at the expense of other stakeholders. The board might engage with management in strategy management though this requires a degree of expertise and knowledge that may not always be present in organisations such as charities, for example. Examiner’s comments There were two key requirements for a successful answer to part (a): the use of an appropriate framework and application to the chosen organisational example. A large number of answers omitted either or both of these elements and described, rather than commented critically, on the situation in the chosen organisation. Answers might have looked, for example, at the balance between focus on efficiency and effectiveness and performance and conformance. (b) Examine the strategic issues involved in a stakeholder approach to governance.

(10 marks)

Suggested answer The stakeholder mode of governance is founded on the principle that wealth is created, captured and distributed by a variety of stakeholders. This may include shareholders but could include other investors, such as banks, as well as employees or their union representatives. As such, management need to be responsive to multiple stakeholders who, themselves, may be formally represented on boards. The advantages of the stakeholder model of governance in strategic terms are:

For stakeholders, apart from the argument that the wider interests of stakeholders are taken into account, it is also argued that employee influence in particular is a deterrent to high-risk decisions and investments.

For investors, there may be a closer monitoring of management, with investors having greater access to information from within the firm. Given that power may reside with relatively few block investors, intervention may also be easier in case of management failure.

It is argued that the major investors, for example, banks or other companies, are likely to regard their investments as long term, thus reducing the pressure for short-term results as against longer-term performance.

© ICSA, 2012 Page 18 of 18

There are also disadvantages of this approach/view:

For management, close monitoring could lead to interference, slowing down of decision processes and the loss of management objectivity when critical decisions have to be made.

For investors, due to lack of pressure from shareholders, long-term investments are made on projects where the returns may be below market expectations.

For the economy, there are fewer alternatives for raising finance, thus limiting the possibilities of growth and entrepreneurial activity.

A further strategic issue of these different governance types is that there are implications for the financing of businesses. In the shareholder model, equity is the dominant form of long-term finance and commercial banks provide debt capital, so relationships with bankers are essentially contractual. This means that the company itself has a higher degree of influence over strategic decisions since the banks are not seeking a strategic involvement with the company. However, if strategies start to fail, the organisation can become increasingly dependent on the bank as a key stakeholder. This often happens in family-owned small businesses. In the extreme, banks may exercise their power through exit (that is, withdrawing funds), even if this liquidates the company. In contrast, in some stakeholder systems, banks often have significant equity stakes or are part of the same parent company. They are less likely to adopt an arm’s-length relationship and more likely to seek active strategic involvement. Examiner’s comments Many of the answers to this question showed understanding of the stakeholder view but the best answers recognised that the question required attention on the strategic issues involved in the approach to governance and applied it accordingly.

The scenarios included here are entirely fictional. Any resemblance of the information in the scenarios to real persons or organisations, actual or perceived, is purely coincidental.