Types of Strategic Change

During the exploitation of the product, a major portion of management energies is devoted to realizing the best possible profitability by means of competitive pricing, promotion, aggressive selling, control of costs, etc. However, there remains an important need for concern within the problem of strategy. The central problem is when and how to introduce new products into the firm's portfolio.

In many industries demand can be stimulated and life cycle effectively expanded through a combination of three types of strategic change: gaining an increasing share of the market, introducing improved products which create a replacement demand, and introducing the product to markets not previously invaded. An expanded life cycle is illustrated in Figure 5.

The product-market changes introduced at points A, B, C have a very strong synergy with the original product market. They address the same type of demand, the same type of customer; they use familiar product technology and rely on the existing organizational capabilities. Thus, this expansion type of strategic change is a part of the natural dynamics of the firm. It is automatically stimulated by pressures from competition, demands from customers, and ideas generated within the firm.

The significant fact is that strategic expansion will take place in most firms regardless of whether the management devotes special attention to guiding and controlling it. Whether such processes will be most efficient when allowed to develop through the natural dynamics of the firm is altogether a different issue. Generally, without explicit planning and control the process will be much less efficient: the timing of introduction will not be optimal, nor will the choice of the means of expansion. Nevertheless, change does take place and assures survival of firms in environments which are not strongly competitive.

The rate of strategic expansion will be determined by the budgets allocated to R & D and to market development. The maximum possible rate is determined, in part, by the resources of the firm. However, there is a natural limit, determined by the capacities of the firm, beyond which additional budget allocations produce declining effectiveness and eventually deterioration in effectiveness of expansion. When pressed to expand at excessive rates, the responsible organizations within the firm begin to suffer from corporate indigestion.

If it is an objective of the management to expand substantially in excess of the rate which can be efficiently generated within the firm, a frequently used alternative is to expand through acquisition from outside. This may include purchase of products developed by others, licensing and acquisition of other firms. Firms which have historically expanded from within do not have built-in organizational capabilities for handling acquisitions. Therefore, expansion by acquisition will not take place, unless the top management first triggers it off and, secondly, allocates appropriate resources and assigns responsibilities for its execution.

In addition to controlling the rate (through budgeting) and the manner (though choice of external versus internal route) of strategic expansion, top management can significantly influence a very strong synergy with the original product market. They address the same type of demand, the same type of customer; they use familiar product technology and rely on the existing organizational capabilities. Thus, this expansion type of strategic change is a part of the natural dynamics of the firm. It is automatically stimulated by pressures from competition, demands from customers, and ideas generated within the firm.

General management is the only level at which information, authority, and the necessary degree of detachment are available to permit a comparison of conflicting claims and a rational allocation of the firm's resources among the various expansion possibilities. Therefore, formulation of strategy is a general management responsibility.

A basically different type of strategic change occurs when the new product-market entries break with tradition and introduce the firm into an unfamiliar area of demand and of product technology. In the normal course of strategic expansion, the responsible departments of the firm (particularly the R & D department) will generate such novel product-market ideas occasionally. Unless the firm has established skills and procedures to exploit these ideas, the only way in which they can be implemented is through intervention by top management. The management is likely to give consideration to them only if they promise truly outstanding profitability. Such unplanned departures from the basic product-market position of the firm represent unplanned diversification. Usually they are random events which seldom have a major impact on the firm.

When a firm deliberately seeks a significant alteration in its product-market position it may undertake planned diversification (6, Chapter 7). This change may be triggered off by adversity such as, for example, a sudden breakthrough by competition which obsolesces the firm's product markets (see Figure 4 for illustration), or it may be caused by inevitable saturation and decline of the current markets, or it may be brought about by a management objective to grow faster than the present prospects permit. The logistic process of the firm is not capable of producing large-scale diversification on the strength of its current dynamics and capabilities. New products and markets must be invented or discovered, new logistic processes must be introduced for manufacture and distribution of these products, new management systems instituted new resource inputs provided. In other words, this change requires redesign and reconstitution of the firm. But this cannot occur without direct involvement by top management of the firm. Therefore, planned diversification will occur only if top management attention is triggered off in the manner described in the last section.

Through appropriate reorientation, the R & D and the market development department of the firm can be directed by management to find and create diversification opportunities. However, the responsibility for diversification usually comes on top of the prior responsibility for expansion. A conflict arises between the two types of activity in which strong pressures favor expansion against diversification. The responsible departments are under continued pressure from the sales department, from the manufacturing department, from customers, from competition, to devote their effort to strengthening and expanding the present products and markets of the firm. As a result, unless management provides continued incentives, influence, and specially earmarked resources for diversification, expansion tends to become the central internal development activity.

Aside from allocation of effort, there is a problem of the direction of diversification. While expansion is to a large extent self-directed by the dynamics of the firm, diversification has no natural direction. Left to themselves the responsible departments, particularly the R & D department, will develop ideas which follow individual interests and technical competence of influential investigators and managers. These directions may not bear any relationship to one another, nor to the capabilities and resources of the firm.

The distinctive feature of the upper 'top management' level is that it has responsibility and control over the entire process of innovation. This group includes the chief officer of the firm as well as his division managers. Together they have a unique perspective of the firm as a whole: of its environment, of its capabilities of conflicting claims on its resources. Their major contribution to innovation arises out of this perspective. It includes the following activities:

(1) Maintenance (either informally through personal contacts, or formally through special staffs) of surveillance of the condition of the firm and of the environmental conditions surrounding it.

(2) Allocation of top management resources among the perceived needs and opportunities (for example, among strategic, administrative, and operating problems).

(3) Development of objectives and of product-market strategy for the firm, allocation of appropriate resources, and assignment of responsibilities for implementing the strategy.

(4) Design of the overall management and logistic systems for the innovative process.

(5) Analysis and selection of specific product-market moves proposed by middle management. (Since this decision requires a firm-wide perspective it should not be delegated.)

(6) Commitment of the firm to exploitation of developed products and providing operating policies, resources, and responsibility.

At the middle management level the responsibilities include the following:

(1) Expanding strategic and policy guidance into specific operation plans, budgets, and procedures.

(2) Design of appropriate logistic and management sub-systems.

(3) Communicating and providing leadership in execution of plans.

(4) Monitoring and evaluating the results, instituting appropriate control actions.

(5) Submitting to top management information and action recommendations at appropriate points in the innovative process.

(6) Providing top management with information relevant to and necessary for effective performance of top management function.

In the problem of strategy the last function acquires particular importance. Effective formulation of strategy requires that top management have available to it the perspective of trends, threats and opportunities to the firm from the vantage point of the senior marketing manager, and particularly, the senior R & D manager. Thus, in a very real sense, both of these managers are responsible for strategy formulation.

The preceding discussion describes the most complete management involvement in the strategic change process which can be found in a business firm. It also contains a prescriptive element in the fact that we have allocated top and middle management responsibilities on the principle that decisions should be made at the lowest levels at which the appropriate and necessary information is available. In terms of observable behavior of firms, it is easy to see why in many firms strategic process can and does proceed with minimal participation from top management. So long as, through the budgeting process, top management allocates resources for innovation, innovation can be managed at middle management levels. The transition between the respective stages of the logistic process becomes more permissive and automatic, strategic action is mainly confined to expansion, the strategy is an implicit one of ' natural ' unplanned extrapolation of the firm's history.

As we suggested throughout the paper, it does not follow that a fully developed system for managing strategic change is the optimal solution for all firms. For a given firm the optimal solution should be arrived at, initially, through determining the firm's strategic needs, secondly, through determining the resources of the logistic process to be devoted to innovation, and thirdly, analyzing the nature of the firm's innovative logistic process and hence its management needs. Throughout this paper we have suggested various hypotheses which can be used as guidelines for this process.

The Nature of Strategic Change

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.

Different Modes of Strategic Behavior

Serial top management decision-making has been characteristic of many business firms in the past and still remains a typical pattern of behavior. An alternative mode of behavior, which is being exhibited by an increasing number of firms, can be called parallel decision-making in which attention to strategy is more direct and response to strategic challenges is quicker. This behavior is modeled in Figure 3.

Attention to strategy can now be triggered in two ways: firstly, through diagnosis of problems signaled by the logistic process, and secondly through a direct response to environmental changes. The nature of this response can vary between firms. It may still be lag response (recognition of a significant change which has already occurred, such as introduction of a radically new product by competitors), it may be anticipatory response in which the firm seeks through forward planning to foresee significant changes in the environment, or it may be self-triggered response in which the firm continuously searches for growth and expansion opportunities. The latter mode is usually described as entrepreneurial behavior. Lag response implies occasional concern with strategy by top management, whereas both anticipatory or self-triggered responses imply attention to strategy which is either continuous or conducted on a regular periodic basis.

Granting that the preceding discussion is properly descriptive of the observable strategic behavior, two questions need to be asked. First, what should be the sensitivity of top management to the problem of strategy, and second, how can such sensitivity be brought about.

The answer to the first question depends on two major factors: the growth and the profitability objectives of the firm, and the characteristics of its product-market environment. In the matter of objectives, we must depart from the micro-economic theory and recognize that both the assortment and the values of goals will vary from firm to firm (5) (6, Chapters 3 and 4). Given the vector of objectives for a firm, the sensitivity to strategy should vary between the extremes of occasional lag responses and of self-triggered behavior, in proportion to the difference between the goals and the potential offered by the firm's present product-market position for satisfying the goals.

The characteristics of the firm's environment have an independent effect on the firm's attention to strategy. Thus, if the present environment appears to hold a satisfactory goal potential, the firm still needs to be responsive to change if the environment is turbulent and subject to changes in products, markets or technology. Thus, management sensitivity to strategy should be proportional to the instability of the environment of the firm.

The question of how appropriate sensitivity to strategy is to be attained takes us into realm of organizational structure and thus outside the self-imposed limits of this paper. Stated briefly, the organizational structure must provide an environment in which top management can devote appropriate attention to strategy, unencumbered by operating demands. The structure must also support this management with appropriate kinds of information and staff support. However, the structure provides only a shell which will operate effectively only if the responsible top management have appropriate entrepreneurial attitudes and skills. It is the difference in these attitudes and skills among managers that is the major determinant of the aggressiveness of a firm's strategic behavior.

We can summarize this section of the paper through a series of propositions about strategic behavior of firms. Descriptive propositions are preceded by the letter D and an appropriate subscript. Prescriptive propositions are coded with N.

D1 Continued profitability and survival of the firm requires that it maintain a product line which remains competitive and in demand.

D2 Strategic decisions, which are concerned with maintenance of a viable product line, compete for top management attention with operating and administrative decisions.

D3 As a result of historical evolution, operating decisions tend to take precedence over strategic unless special provisions and/or circumstances arise.

D4 The major factors which determine the degree and continuity of attention devoted to strategy in the firm are the following:

(1) A history of unprofitable operations.

(2) Entrepreneurial propensity and training of top management.

(3) Organizational structure which makes special provisions for attention to strategy.

(4) Gap between objectives and past performance.

(5) Gap between objectives and forecasted performance.

(6) Past history of active concern with strategy.

(7) Forecasted instability of the firm's environment.

(8) Active strategic behavior by the firm's competitors.

D5 The above factors combine to produce an observable strategic behavior which ranges from lag response, in which operating decisions take precedence, to self-triggered response in which strategy is attended to continuously and independently of operations.

Ni A particular firm's position between these extremes within this range should be proportional to:

(1) The gap between the objectives and the future potential of the firm's present strategic position.

(2) The degree of instability of the firm's present product-market environment.

N2 The organizational structure of the firm should be designed to provide adequate resources and management attention to the strategic needs of the firm.

N3 Top managers charged with strategic decisions should be selected on the basis of their entrepreneurial propensities and talents.'