We shall define a strategic change as a shift in the product or service mix produced by the firm and/or the markets to which it is offered.' A key step in the shift is the discovery of a product-market idea. However, before the idea becomes a part of the firm's product-market portfolio several other steps must be taken: enough information must be developed to convince management of the profitability of the idea, organizational competence must be developed for manufacturing, distributing, and marketing the product; recognition and acceptance by potential customers must be gained for it. Thus strategic change is not an instantaneous event, but a protracted time and cost consuming process.
Discovery of a novel product-market idea is a creative act; the idea must be either invented inside the firm (usually by R & D or marketing departments), or searched out from among opportunities which exist outside the firm. This process of discovery (which is often called search) is usually costly and time consuming. As a result, when the management first commits itself to strategic change, it is not able to align all of its future opportunities; some will be known at the outset but the others will only be found through search.' The management problem at the outset is not to select the preferred opportunities, but rather to provide guidance and coordination for the firm's search for opportunities. The central issues are: (1) How much of the firm's resources should be committed to known opportunities, how much to search, and how much held in reserve? (2) How specific can and should be management guidance of an essentially creative process?
An influential factor in determining the scope of search is the affinity between search areas and the present position of the firm (6, Chapter 5). This affinity (which has been called synergy or `2 x 2 = 5') can express itself in a number of ways: (1) through use of common skills and facilities by the new and the old product-markets; (2) through complementarily of skills contributed by respective product-markets.' Existence of synergy enhances the potential joint profitability of the enlarged strategic position and also reduces the risks inherent in the new move. On the other hand, overemphasis on synergy can unduly restrict the field of opportunities and suppress the creativity of the search process.
Striking of a balance between these two extremes is one of the central management problems in formulation of strategy.
Another influential factor in determining the scope of search is the critical mass, which is the investment required in a product market area for a viable and successful entry. Limitations of resources make it unprofitable for a firm to search in areas which are beyond its means.6 A commitment of search to a number of smaller areas, whose aggregate critical mass exceeds the firm's resources, can overextend the firm, unless the process of search is carefully controlled by management.
A third factor which determines the most effective scope of search is the concentration of effort brought to bear on a given area. If the search varies widely, the effort devoted to an area becomes highly diluted. Each part of the scope does not receive adequate resources to permit exploration in depth. As a result, evaluation of the potential of the area becomes highly tentative and uncertain. As the search is concentrated, better knowledge of the area improves judgment and evaluation of prospects, but may put the most attractive opportunities outside the scope.
An idea discovered as a result of search commends itself to management attention, because it appears profitable. However, at the outset the estimates of profitability are usually very rough. Information is lacking about what it will take to develop the needed capabilities, what resources must be committed, how many units will sell, at what prices, etc. In fact, usually it is not even known whether the first prototype will work as expected. As a result, discovery is usually followed by what is called the product or process development process, which is primarily concerned with proof of profitability of the idea. This process involves development of working prototypes, constructing a pilot production line, conducting a pilot marketing test. As the process progresses, the information about profitability improves and uncertainties are reduced; but, at the same time, investment rises at an increasing rate.
This poses another central problem in managing strategic change: to organize and direct the development process so that the proof of profitability is obtained at the least cost and at the earliest possible time. In the course of development the continuously current issues are: (1) Is the information sufficient for a decision? (2) Should further development be undertaken? (3) Should the development project be discontinued? (4) Should it be reoriented in a direction which now appears more promising? (5) Should the development be accepted as finished?
In the course of the development process, the firm develops not only a proof of profitability but also some skills and organizational capabilities required by the new product. However, the primary emphasis is on developing information. Thus, for example, firms usually confine themselves to limited pilot facilities and to local test marketing. When a point is reached at which management is prepared to commit to the new product-market, the major emphasis is shifted to development of organizational skills and capabilities for producing and marketing the product. We shall call this distinctive period in the life of a strategic change capability development. During this period full-scale manufacturing facilities are built, market and distribution channels established, new management systems introduced, personnel trained, material stockpiled, etc. Usually the investment rises much faster than during product development and the central management problem is to build up the capabilities at least cost and time.
The capability development period comes to an end when the management feels ready to launch the new product on a full scale. The period of exploitation which sets in follows a characteristic life cycle, illustrated in Figure 4. At the outset the demand for a newly introduced product rises at a fast rate, while various competitors seek to acquire market shares and profitability is uncertain and low. This is followed by a steady growth period during which market shares are established and profits are good. Toward the end saturation sets in — a leveling of demand and decline in profitability; then comes an eventual decline in demand.
Figure 4 shows what might be called a natural life cycle whose shape is determined by the economic forces of demand.' Increasingly during the past sixty years, life cycles of products have been suddenly distorted by competitive breakthroughs which, through introduction of new technology, suddenly obsolesce a preceding product and send it into an accelerated decline. This is illustrated at point A on Figure 4.
Whether as a result of a breakthrough or natural saturation, a point finally arrives at which the product is withdrawn from the market. The decision to divest the firm from a product is one of the most difficult in the entire history of a strategic change.
The signs of product obsolescence are hard to detect, particularly if the management operates according to the serial decision model of Figure 2. Usually there is also a great deal of organizational inertia and personal commitments to an old established product-market position. Managers typically tend to disregard the economists' `sunk cost' principle, which states that the decision to divest should be based entirely on comparison of future prospects, and not on how much money and resources were invested into the project in the past.
As a result, a lag response to divestment is typical and frequently costly to the firm, for it precludes timely initiation and the introduction of superior products. Thus a key management problem during the exploitation period is to keep the product in a proper life-cycle perspective, and to avoid losing this perspective through preoccupation with tactical competitive challenges and operating problems.
Following a divestment decision a divestment phase sets in during which the management problem is two-fold: (a) To salvage as much as possible of the resources invested in the product and (b) to assure a smooth organizational transition to the new level (and frequently type) of operation. At the termination of the divestment period, the history of a strategic change comes to an end.
We can summarize the characteristics of strategic change discussed this far by means of the following hypotheses:
D6 Strategic change characteristically takes place under conditions of partial ignorance under which only some of the potential product-market alternatives are known at any time.
D7 Discovery of new alternatives is accomplished through a process of creative search which is both cost and time consuming.
D8 Given two fields of equal growth and profitability prospects, search in the field of higher synergy will produce opportunities with higher profitability and lower risk to the firm.
D9 Search in areas in which the critical mass exceeds the resources of the firm will generate opportunities which the firm will not be able to convert to profitable products (even if the opportunities are inherently profitable).
D10 The accuracy of the original estimates of profitability and risk inherent in a new idea, which is discovered in a particular area, vary in proportion to the amount of the resources previously devoted to search in that area.
D11 The probability of discovery of new ideas varies directly with the scope of search.
D12 The factors which determine the scope and the amount of effort devoted to search in business firms are included in the following:
(1) Top management propensity for opportunities with high synergy.
(2) Top management propensity for risk taking.
(3) The resources available for search (correlated to size of firms).
(4) Availability of attractive opportunities in high synergy areas.
(5) The sense of urgency for strategic change as perceived by top management.
(6) The skills available within the firm (particularly in the marketing and R & D departments).
(7) The personal search propensities of the executors of the search process.
(8) Glamour of certain growth areas as perceived by the investment community.
(9) Past search patterns of the firm.
(10) Competitive pressures.
(11) Desires and needs of the firm's customers.
D13 Initial estimates of risk and profitability of a new product-market idea are refined through a process of product development which terminates in acceptance in or rejection of the idea.
D14 An idea is accepted or rejected when in the management's judgment (a) additional development will not significantly change the present estimates of risk and profitability or (b) when the cost of additional development will reduce the ultimate profitability below a level acceptable to management.
D15 Acceptance of an idea for implementation triggers a process of capability development which is aimed at developing skills and organizational competence needed for exploitation of the developed product.
D16 The decision to exploit is arrived at when the firm's competence is judged to be adequate to support an aggressive effort to manufacture and market the product.
D17 The sub processes of search, product/process development, capability development and exploitation tend to overlap toward the end of each process.
Our prescriptive hypotheses are as follows:
N4 The entire processes of strategic change should be planned and guided by the management of the firm. The plans should be written and explicit, feedback data from the process should be used for revision of plans.
N5 The process of search should be limited and guided by a product-market (6, Chapter 6) strategy, formulated by the firm's top management.
N6 The effort devoted to strategic change should be determined by:
(1) The size of the discrepancy between the objectives of the firm and the prospects of the current product-market position
(2) The total resources available to the firm
(3) The intensity of competition and the rate of change in the technology and structure of the markets.
N, The scope of search should be determined by:
(1) The resources available for the entire process of strategic change
(2) Critical mass requirements of opportunities in the area of search
(3) The depth of competence within the firm and hence its synergy potential
(4) Availability in high synergy areas of opportunities which can meet the objectives of the firm
(5) Actions by the firm's competitors.
N8 During the process of product development the primary objective of the management should be to secure at least cost and shortest possible time, information which is adequate for rejecting or accepting the project for exploitation.
N9 During product development the project should be continually monitored to determine adequacy of information and the desirability of reorienting the project toward more promising objectives.
N10 During the process of capability development the primary objective should be to develop capabilities adequate for exploitation of the product.
N11 During the exploitation period the product-market must be continually monitored with respect to:
(1) Its natural life-cycle position
(2) Probability of breakthroughs which may change the natural life cycle.
N12 During the exploitation period, periodic review and decision should be made on whether the product should be continued, withdrawn, or replaced by an improved product.
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