Riverside Management Academy Pvt. Ltd. Partnering in the Journey towards excellence

STRATEGY: THE ROLE OF THE BOARD OF DIRECTORS

1. INTRODUCTION

1.1 MISSION AND VISION – THE CORE THAT DOES NOT CHANGE

There is no clarity on what is the difference between the mission and the vision of companies. Some hold the view that the ‘mission statement’ of a company articulates the purpose of the organisation, while the ‘vision statement’ articulates the desired future state of the organisation. According to them the ‘mission’ reflects the values and expectations of major stakeholders and decides the scope and boundaries of the organisation. There are successful companies, which articulate only the mission, while there are others, which articulate both the mission and vision. We shall use the ‘vision and mission’ together without making an effort to distinguish between the vision and mission.

Every visionary firm articulates its core purpose, which is the reason for its existence, in its vision and mission statement. The core purpose of a firm cannot be ‘creating shareholder value’. A firm should be economically successful for its sustainability and growth, but earning money cannot be the purpose. The core purpose is much more deep and meaningful than simply making money. It attracts and inspires people to work for the company. Although the core purpose of a firm is not carved on stone, but it does not change over a very long period, say, over a period of hundred years. Even if a visionary firm does not articulate its vision and mission, we may derive the same from its way of working and other statements.

 

Vision, Mission and Values: Examples

TCS

Mission

Our mission reflects the Tata Group's longstanding commitment to providing excellence:

·         To help customers achieve their business objectives by providing innovative, best-in-class consulting, IT solutions and services. 

·         To make it a joy for all stakeholders to work with us.

Values

Our values: Leading change, Integrity, Respect for the individual, Excellence, Learning and sharing.

PHILIPS

Mission

Improving people’s lives through meaningful innovation

Vision

At Philips, we strive to make the world healthier and more sustainable through innovation. Our goal is to improve the lives of 3 billion people a year by 2025. We will be the best place to work for people who share our passion. Together we will deliver superior value for our customers and shareholders.

Behaviours

·         Eager to win

·         Take ownership

·         Team up to excel

 

For example 3M introduces itself as a global innovation company that never stops inventing. It writes “Every day at 3M, one idea always leads to the next, igniting momentum to make progress possible around the world.”  3Mgives, the corporate philanthropy arm of 3M writes[1]:

“3M is a science and technology company that creates.  For decades, 3M scientists and engineers have developed products that solve problems. 3M is also a company that cares – improving lives each day.  The mission of 3Mgives: To Improve Every Life through Innovative Giving in Education, Community and the Environment – mirroring our corporate vision: 

3M Technology Advancing Every Company

3M Products Enhancing Every Home

3M Innovation Improving Every Life”  

From the above we may easily infer that technology and innovation are at the core of 3M’s operation and that has not changed for decades.

Another component of vision and mission is ‘core values’. Core values do not change over a long period, say over a period of hundred years. Visionary firms do not deviate from core values even in situations of adversity. Every member of the organisation has high level of commitment to those values and holds the same even when the firm or the individual is passing through a crisis situation.

Vision and mission defines the corporate philosophy and determines the culture of the firm. It is aimed at internal stakeholders. It is not a set of verbose statements for external consumption. Every member of the internal stakeholder groups is committed to the vision and mission and takes it as the guidepost. Vision and mission does not set goals that are to be achieved.

1.2 BHAG – ENVISIONED FUTURE

Collins and Parras[2] have introduced the concept BHAG (pronounced BEE-hag and short hand for Big, Hairy, Audacious Goals). According to Collins and Parras, a firm should establish vision-level BHAG and ‘envisioned future’ should be a component of the vision and mission statement. BHAG are goals that the firm plans to achieve in next ten to thirty years. Those goals are achievable, but achieving them poses a ‘huge and daunting challenge’. Ultimately the firm may not achieve those goals, but they inspire employees to make extraordinary efforts to achieve them. They believe that those are achievable with a bit of luck. For example, PHILIP’s vision includes the statement ‘our goal is to improve the lives of 3 billion people a year by 2025.’

Public documents like ‘vision and mission’ usually do not include BHAG. But highly successful firms develop BHAG and clearly articulate the same to all internal stakeholders.

BHAG is not core like purpose of the firm and its values. Therefore, it does not last forever or for a long period, say hundred years. Firms reset BHAG after earlier BHAG are achieved. It is very difficult to achieve hundred percent of BHAG. Therefore, firms reset BHAG after the end of the time horizon for which the BHAG was established even if it achieves less than hundred percent of the target. Failure to reset BHAG might lead to complacency.

2. STRATEGY

Vision and mission is not strategy. It is not core and therefore, it changes with changes in the internal and external environments. However, strategy reflects corporate philosophy and corporate culture, which are core and do not change with change with changes in the internal and external environments. It is said that success comes from one percent vision and 99 percent alignment. Therefore, strategy execution is as important or even more important than strategy formulation to achieve success.

Two-levels of strategy

A multi-business firm has two levels of strategy. The corporate strategy applies to the whole enterprise. It is about deciding the portfolio of businesses and the way the corporate office supports each business to create value that is higher than the value that the business could create on stand alone basis.

Business strategy focuses on individual business. It is about winning in the market.

2.1 NATURE OF STRATEGY

Strategy provides long-term direction to the firm to achieve BHAG. In a dynamic environment, the time frame of strategy is usually shorter than that of BHAG. The time frame of the strategy depends on the business environment in which the firm operates.

Strategy is about building business portfolio and positioning the business in the market place. It is about constructing alternative course of actions and making hard choices of what activities to do. It is also about deciding what activities not to do, as they are incompatible with chosen activities or the image or reputation of the firm. Strategy is about making a tradeoff between different options available before the firm and achieving coherence between different chosen activities. The chosen activities should be unique or they should be done differently from the way competitors perform those activities. The aim is to create competitive advantage over competitors. The position is sustainable when activities or the process as a whole is inimitable.

STRATEGY BY DESIGN

Often the term ‘strategic planning’ is used to denote that strategy formulation is a rational planning process, which endeavours to fit the firm’s strength and weaknesses with the opportunities and threats in the external environment. The top management designs strategy to be implemented by others.

The process of setting strategy involves: analysing the current strategy (called position audit), appraising the corporate resources and capabilities, PESTEL analysis
analysing the external environment (political, economic, socio-cultural, technological, environment and legal,), analysing strengths, weaknesses, opportunities and threats (SWOT analysis), developing strategic options, and choosing the best option.

EMERGENT STRATEGIES

Strategy that companies follow might not be the same that was planned. Strategy emerges in the course of doing business.

Management may deliberately create conditions for ideas and strategies to emerge. It continues with the current strategy until it detects structural discontinuity in the environment. It develops the skill for early detection of those discontinuities. Management assesses the impact of discontinuity on the current strategy. Based on that assessment, it changes the strategy. Usually it allows new strategic initiatives throughout the organisation and intervene when a clear pattern emerge. It reconciles change with continuity and checks radical change in the strategy.

OTHER PERSPECTIVES

Sometime, strategy reflects the pattern of decision making within the firm. A coherent strategy (or strategic approach) emerges out of series of decisions, such as launching of a new product or service, a decision to acquire a business, or a significant investment decision.

Strategy may also be viewed as building resources and core competencies (unique systems and processes that are inimitable) to build competitive advantage over competitors.

3. BUSINESS STRATEGY

3.1 PLAYING TO WIN

Lafley et al.[3] has explained strategy as answers to the following five questions:

(i) What is your winning aspiration? Articulate the purpose of your enterprise and its motivating aspiration.

(ii) Where will you play? Choose the playing field where you can achieve the aspiration.

(iii) How will you win? Choose the way you will win on the chosen playing field.

(iv) What capabilities must be in place? Map the set and configuration of capabilities required winning in the chosen way.

(v)What management systems are required? Design the systems and measures that enable the capabilities and support the choices.

The model presented by Lafley et al. can be applied in formulating both the corporate strategy and the business strategy.

Winning Aspirations

Winning aspirations are statements of ideal future. They should be well defined. They define the scope of the business (firm). A firm wins in the market place with customers and against the very best. Therefore, winning aspirations usually focus on customers. They are articulated in the vision and mission statements of the firm. For example, the vision statement of Hindustan Unilever Limited is:

“We meet everyday needs for nutrition, hygiene and personal care with brands that help people feel good, look good and get more out of life.”

Winning aspirations can also be viewed as ‘envisioned future’ discussed above.

Where to Play

Answer to the question ‘where to play’ defines the choice of:

·         Markets;

·         Consumers and customers;

·         Channels;

·         Product categories; and

·         Segments in the value chain.

Winning aspirations broadly defines the firm’s activities. ‘Where to play’ choices narrow down the competitive field.

How to Win

Answer to the question ‘how to win’ defines the choice of what to do to create and deliver unique value, which is distinct from competitors, to consumers and customers sustainably. ‘How to win’ choice should fit with the choice for ‘where to play’. Choices for ‘How to win’ and ‘where to play’ should be decided together.

What Capabilities

Answer to the question ‘what capabilities’ maps the activities and competencies that are critical to support ‘where to play’ and ‘how to win’ choices. Core capabilities should support and reinforce one another. They together create the competitive advantage over competitors.

What Management Systems

Answer to the question ‘What management systems’ identifies the management systems that foster, support and measure the strategy. They must be purposefully designed to support the choices and capabilities.

3.2 STRATEGY DIAMOND

Some authors present the five elements of strategy in the form of strategy diamond. The elements are arenas, vehicles, differentiators, staging and pacing and economic logic. All the five elements should be coherent. Coherence is essential to win in the market place.

 

 

Arenas

Firms choose arenas by answering the question where to win. Arenas must be very specific. Choice of arenas determines what the firm shall do and what it shall not do.

Vehicles

Vehicles are the means of participating in target arenas. A firm may choose from various vehicles such as internal development, joint ventures, alliances, acquisitions and licensing/franchising. Making a choice is similar to answering the question ‘how to win’.

Differentiators

Differentiators are features and attributes of the products and services that are being offered by the firm, which help it to succeed in the market place. Differentiators drive customers to choose firm’s products and services over those of competitors. Examples of differentiators are image, customisation, technical superiority, price and speed to reach the market. In order to be successful, a firm has to choose the differentiators early. Choosing differentiators involve tradeoffs among various opportunities available before the firm. The firm should be consistent in choosing differentiators.

Staging

Staging refers to timing and pace of strategic moves to enter new arenas. The choice depends on availability of capabilities and other resources, including financial resources. It also depends on the likely strategic moves of competitors.  For example, a firm, which aspires to become an international player, has to decide the timing and pace of entering international markets based on emerging opportunities and available capabilities and other resources.

Economic Logic

The core objective of a business firm is to earn a return on investment that is higher than the cost of capital. Economic logic refers to how the firm will create economic value for shareholders.  Developing the economic logic requires understanding of both costs and revenues arising from various strategic options available before the firm.

4. STRATEGY FORMULATION

 

Rumlet[4] identifies the following three critical steps in formulating and implementing strategy:

·         Diagnosis,

·         Formulation of a guiding policy and

·         Developing a set of coherent actions

Diagnosis

Diagnosis is answering the question ‘what is going on here?’  Diagnosis classifies the situation, linking facts into patterns and calls attention to crucial aspects of the situation. Diagnosis aims at developing different perspectives of the situation and to gain insights. Different perspectives may be developed on the same situation. For example, one perspective on the emergence of a new technology might be to consider it as a threat, while the other perspective might be to consider the same as an opportunity.  Different perspectives lead to different guiding policies. Therefore, it is important to develop the right perspective. It requires in-depth analysis of the situation. Factors that are observable on the surface might not be the real factors, which have caused the situation. 

Diagnosis defines a domain of actions.

Guiding policy

Good guiding policies define a method of dealing with the situation diagnosed by the strategist. A guiding policy creates advantage by anticipating the actions and reactions of others, exploiting the natural or created imbalance in a situation (e.g., under- or over-served customers, unfulfilled demand and gap between the position of a competitor and its capabilities) and creating policies and actions that are coherent. Guiding policy does not set out the goal. Examples of guiding policy are ‘to provide complete turnaround solutions to underperforming firms’, ‘to provide natural leather handcrafted accessories to those who value designer products’, and ‘to produce motorcycles that are evocative and engaging and great fun to ride for global mid-size motorcycle market’. Guiding policy guides the choice of actions.

Coherent Actions

Actions, such as resource allocation and policies, which are undertaken, should be consistent and coordinated. Only coordinated actions provide the advantage that is necessary to win in the market place. For example, a low cost producer keeps the cost low by adopting large number of interrelated policies and activities.

5. STRATEGY EXECUTION

Formulation of a good strategy is not enough to achieve targets set in ‘envisioned future’. Effective execution of the strategy is equally important, if not more important. It requires clear articulation of the strategy in simple terms to enable everyone who is associated with the execution of the strategy to understand the same. It should clearly spell out the course of actions, what to do and what not to do.

Assumptions underlying the strategy should be debated to ensure that the assumptions are realistic and are valid at the time of execution. If the reality is different from underlying assumptions, the strategy should be revisited.

Resource gap and the need for investments should be identified early and adequate resources should be allocated to the business. Similarly, gap in capabilities and competencies should be identified early and necessary capabilities and competencies should be developed with speed.

Appropriate systems and structures should be put in place to support the execution of the strategy.

A rigorous framework for monitoring the progress of the strategy should be developed. For example a model similar to balanced scorecard may be developed to monitor performance and to identify the gap between the strategy and performance to enable the management to take necessary actions to bridge the gap. The performance should be compared with financial and non-financial targets of the long-term plan.

Proper incentive schemes should be put in place to motivate and encourage employees to execute the strategy and to build execution capabilities.

6. CORPORATE STRATEGY

 “Corporate strategy cannot succeed unless it truly adds value—to business units by providing tangible benefits that offset the inherent costs of lost independence and to shareholders by diversifying in a way they could not replicate.”[5]

Multi-business firms has three choices:

·         Where to compete (choice of businesses)

·         What to own (choice of firm boundaries)

·         How to organise (choice of structures, processes and incentives)

6.1 Choice of Businesses

Expansion on new business should either benefit the existing business or the new business. Benefits arise either from cost-side synergies or revenue-side synergies.

Cost-side synergies

Cost-side scope economies might arise from centralizing procurement, combining staff functions, economies in distribution and logistics, or common production platforms.

Revenue-side synergies

Revenue-side scope economies arise from the convenience of one-stop shopping, bundling, or cross- selling. Businesses are related when they share either activities that are unique to the firm or resources (e.g., a common brand, reputation, specific knowledge or expertise, managerial talent, or a common culture) that are unique to the firm.

Choice of Boundaries

A firm needs to decide whether it will expand through ownership of the new business or by some other kind of arrangement. Expansion through ownership is justified only in a situation where the market or the contract fails. Firms choose expansion through ownership only if it can create higher value in the business or enhance its share in the value being created by the business.

Absence of market

When the firm develops a new product, it might be required to develop the whole or some parts of the value chain simultaneously. For example, when an automobile manufacturer introduces a vehicle manufactured using the state-of-the-art technology, it has to provide after-sales services, at least in initial years. In later years the market expands and other firms (independent players) get attracted to other parts of the value chain.

Relationship specific investment

Investment in assets that have no use other than supplying goods or services to a particular customer has hold up cost. Writing a long and elaborate contract reduces the hold up cost. However, in certain situations, it might be difficult to write such contracts. In those situations, the firm favours to own the customer’s business to avoid the problem of redistribution of value being created in the business.

Coordination

In some businesses cost of coordination between different parts of the value chain is high. For example, where the demand for the product is volatile, coordination cost is high. In that situation a single firm would favour owning up different parts of the value chain.

Resolving double marginalization problem

Where both upstream and downstream businesses enjoy monopoly power, all firms endeavour to extract monopoly margin form customers. As a result the price for the end product goes up and adversely affects the demand for the product. Vertical integration resolves this problem because a single firm decides the transfer prices that optimise the profit of the firm. Customers also benefit from such vertical integration.

Choice of organisation

It is important to assess the tension that might arise because different businesses are to be structured differently to extract the full potential value from the business. For example, a business requires autonomy, while the other requires centralisation of some activities. Similarly, it is appropriate to have different incentive schemes for employees should be different for different business. Even it might be difficult to develop a common culture.

7. BOARD’S ROLE

The Companies Act 2013 requires that independent directors should bring independent view while discussing and deciding strategy. The Board has the responsibility to oversee the strategy process.

In most companies the management owns strategy. It formulates the strategy and presents before the Board for approval. At the minimum, the Board should understand how the company is creating value. The level of Board’s engagement with strategy formulation depends on the context.

It is not that strategy of companies change continuously. Therefore, normally, the Board’s role is to supervise the strategy process –formulation, implementation and controls, including risk management. Periodical review of the current strategy by the Board is essential as it helps to detect weak spots early for taking corrective actions. The Board might decide to modify or abandon a strategy if it is not working well for the company. Strategy evaluation is not the same as performance evaluation. Strategy evaluation requires maintaining and analysing data collected from both the external environment and internal environment to detect subtle structural changes that would provide new opportunities or might pose new threats to the current strategy. The Board should develop the skills to analyse external and internal data and to pay attention to details. The Board should continuously review strategy implementation.

When the management presents a new strategy, the Board should challenge the assumptions. In a complex situation, the Board may co-create the strategy by bringing outside perspective, which helps to objectively diagnose the situation and making hard choices.

Board can also help in implementing strategy by bringing resources, for example, by leveraging individual director’s contact and relationship with other stakeholders, say with the government. The Board may garner support for the company to help it in implementing strategy.

7.1 DIALOGUES IN THE BOARD ROOM

This section presents the expected dialogues in the boardroom. In successful companies those dialogues are common at every level of the organisation, particularly at senior levels of the management. Such dialogues only at the Board level do not lead to success. Board level dialogues create the culture of discussing strategic issues at various levels of the management and strengthen the oversight function of the Board.

A firm earns above average profit only when it is able to identify imperfections in the market and take advantage of those imperfections. Imperfections are scarce and fleeting. A firm beats the market when it is responsive to ever changing market imperfections. Therefore, the board should discus whether the firm is ‘just playing along’ or has created an ‘advantage’ by doing something different from what its competitors are doing and how it has prepared itself to respond to challenges from potential entrants and potential substitutes. 

Firms enjoy competitive advantage due to its ‘positional advantage’, ‘core competencies’ and control over unique resources. Usually incumbents enjoy positional advantage due to industry structure. The positional advantage erodes due to change in the industry structure. Therefore, it is important for the Board continuously review the relationship among the industry structure, positional advantage and performance of the firm to detect early the signs of changes in the industry structure and erosion of positional advantage. This helps firms to develop right responses.

Core competencies refer to special capabilities that are inimitable. Usually, competitors cannot imitate core competencies when activities are bundled together to create competitive advantage. Core competences are available in abundance within the firm and are scarce outside. Capabilities do not remain ‘special’ when it becomes available outside the firm. Special capabilities fail to provide competitive advantage due to change in the business environment such as emergence of new technology, change in demography and change in government regulations.

Control over unique resources (such as an advantageous location, mines with high quality ore, and patent) is also a source of competitive advantage.

The Board should understand clearly the sources of competitive advantage in order to identify develop right strategy to develop sustainable competitive advantage. This requires in-depth analysis of the drivers of performance because often it is difficult to identify the true sources of competitive advantage.

The Board should discuss the emergence of new trend to identify early such trends. Trends emerge slowly and become obvious when they hit the business. Therefore, there should be serious trend analysis to understand how the emerging trend would impact the business by posing new challenges and creating new opportunities. Successful firms identify trends early to develop effective strategic response. Firms that fail to identify trends before they become obvious find little time to develop appropriate strategic response. However, early identification of trend is not enough. Developing appropriate strategy requires ability to challenge status quo and take hard decisions.

Successful companies develop ‘proprietary insights’. Having insights that are available to all cannot create competitive advantage. The routine analysis of data and reports that are available to all does not provide ‘proprietary insights’. Developing such insights requires collection of proprietary data or innovative ways to analyse publicly available data. Generally, analysing data from customers’ perspective help to develop ‘proprietary insights’. The Board should spend time in understanding ‘proprietary insights’ developed by the management.

There should be a balance between commitment and flexibility. Successful execution of strategy requires alignment of resources with strategy.  It is important that right amount of resources are committed at the right time. For example, commitment of significant resources to take advantage of an emerging opportunity might not be a wise decision. A small amount of resources is committed, similar to buying an option, at the stage when the opportunity is ambiguous and not clear to ensure that the firm does not lose out when the opportunity will actually arise in future. The Board should discuss the commitment of resource to ensure the balance between commitment and flexibility.

The Board should discuss the logic and assumptions underlying the strategy. This is important to ensure that the strategy is free from bias.

7.2 BOARD INFORMATION FOR STRATEGIC OVERSIGHT

 

Topic

Minimum Frequency

SITUATION (The objective is to assess the trend and validity of business logic and assumptions underlying the strategy)

 

External Environment (PESTEL) Audit Report (Political, Economic, Socio-cultural, Technological, Environment and Legal)

Annual

Competitor Analysis

Annual

Competitive positioning of the company

 

SWOT Analysis (Strength, Weakness, Opportunities and Threat)

Annual

Report on key risks

Annual

STRATEGY IMPLEMENTATION (The objective is to assess the effectiveness of the implementation of the  action plan formulated to achieve strategic objectives.)

 

Report on capital expenditure, acquisition, divestiture (Deviations from the original/revised plan)

Annual

Report on major policies, systems and organisation structure (Deviations from the original/revised plan)

Annual

Report mapping capabilities to strategy (Deviations from the original/revised plan)

Annual

Report on resources, which are not creating value

Annual

Budget

Annual

MONITORING AND CONTROL (The objective is to detect the signals showing weakness in the strategy itself or in strategy implementation)

 

Performance against key performance indicators (financial and non-financial) for each business: Balanced Score Card may be used

Quarterly

Progress report on capital expenditure

Quarterly

Report on risk management

Quarterly

Report on the effectiveness of internal control

Quarterly

STRATEGY FORMULATION (The objective is to evaluate a proposed strategic plan or prosed revision in the current strategy)

 

Five-year corporate plan (corporate strategy and business strategies)

Every five year

Revision of current strategies (corporate strategy and/or business strategies)

As required