What is a strategy?
Term strategy is quite loosely used in industry and even in real life. As defined by Michael Porter in 1996 (Porter, 1996) that operational effectiveness, total quality management, benchmarking, re-engineering etc. is not a strategy. Similarly, the idea of doing something different in a situation is a simple trick but not a strategy. The argument is based on the logic that these steps or activities, though provided gains to the firm in short run but could be easily imitated by the competitors hence rarely lead to a source of sustainable growth. Hence the bigger question arises, what is a strategy? Hence, there are several definitions of strategy which indicates it’s an art and science at the same point of time. Michael Porter suggests the set of activities which may provide sustained competitive advantage in the market in which the firm is operating may be defined as the strategy. Further, the sustained competitive advantage may be considered as those resources which are either hard or soft which is inimitable or difficult to imitate, is valuable, rare and there is readiness for it inside the organization. In parallel, it has been argued that sustained competitive advantage is the factors which can give the organizations the access of wide range of markets, increased benefits of the consumer, and difficult to imitate (Prahalad and Hamel, 1990).
Mintzberg in his 5 P model (Mitzberg, 1987) gave five alternate definitions or say classification of strategy namely plan, ploy, pattern position, and perspective. Strategy as a plan gives two attributes of strategy – first, it is made well in advance of the actions to which they apply, and second, it is developed consciously and purposefully. Game theory describes strategy is a complete plan where every player opts for a choice in every situation which means, these choices must be evaluated against various situation scenario well in advance. Strategy as ploy indicates one important aspect of the market which is moves and counter-moves. It describes a set of acts which an organization performs to outwit its competitor in a particular market. These ‘manoeuvring’ may or may not be scalable in terms of time and space which means similar kind of move may not work in every market and every time. The strategy is a plan proposes to identify the pattern in a series of action of both itself as well as for the organization. It will help in both plan based as well as ploy based strategy. Strategy as a position is yet another approach of defining a strategy where it is intended to position the firm in the marketplace. Hence, strategy as position are set of activities which help in coordinating organization and with its outer environment. Strategy as perspective looks inside the organization and identifies the factor which may give it a competitive edge (Mintzberg,1987).
Hence, it has been understood that strategy should be formulated with great planning which in itself is a complex process.
The term planning, though used loosely, but is an important management function which involves the formulation of detailed blueprint comprising of clear steps to achieve a particular goal with available resources in stipulated time and under stipulated constraints. The planning process involves a series of steps which involve identification of goal and objectives which need to achieve, formulate a detailed blueprint to achieve those goals under stipulated time, and constraints, assessment of resources, reformulate the blueprint if required to achieve those goals under stipulated time resources, and constraints, implement the blueprint and do the course correction if requires (Brooks, 2002).
Rational planning further gives directives about how to do planning which involves rational or say scientific tools and techniques. Rational planning involves five key steps which are the definition of the problem, identification of alternatives, evaluation of alternatives and therefore selection of a plan, implementation of the plan, and monitoring of effects. The rational planning also enables the decision makers to take logical decisions which are not based on gut-feeling but backed by data and scientific analysis. The rational planning model is logical and follow the orderly path from problem identification to the execution of solution idea. Hence rational planning always proposes frameworks and tools for making strategic decisions. One of the key advantages of using tools and frameworks is the fact that it mitigates the impact of biases while making any decision ((Brooks, 2002).
Combining rational planning with strategy formulation
Strategy formulation frameworks when aligned with rational planning always boils down to either or a combination of five P as proposed by Henry Mintzberg.
Prima facie, a strategic plan can be broken down to two major phases i.e. strategy development and strategy deployment. Strategy development is the development of blueprint for the growth of organization while strategy deployment implies the set of activities involved for implementing the blueprint. Some of the critical questions which strategic development model tries to answer are as follows:
- What is the purpose of existence of the organization?
- What business organization wants to do?
- What are the hard and soft resources owned by the organization, hence what are strengths and weaknesses?
- What is the competitive landscape in which the organization operates, hence what are the opportunities and threats organization faces?
- Therefore, where the organization wants to position itself in the future?
Summarizing above helps the organization in determining its vision and mission which is fundamental to strategy formulation for any organization. Once vision and mission get fixed, the next step is to formulate the goals for walking on the mission to achieve the vision. The goals are generally specific, measurable, and high-level objectives to achieve the vision and mission. Once goals are set, high-level action plan is developed aiming to achieve the desired objectives. While formulating strategy, an organization should be clear about their competencies and core competencies, the critical success factors, and the organizational values (Collins, J, and Jerry I. P., 1996).
As discussed above next phase is the strategy deployment or strategy implementation which involves the execution of the strategic plan. Execution of strategic plan involves a proper assessment of external environment such as markets and submarkets, the perception of consumers, the competitiveness, statutory policies etc. and of the internal environment such as estimation of the budget, the requirement of time, and availability of skills. Further, need gap analysis is done which gives a fair estimate to organization about the additional requirement of resources both hard and soft for executing the plans. Post-assessment, blueprint for execution is being rolled out. Execution plan should always have provisions of contingencies and alternatives, in case a particular project stalls. Finally, it should have provisions of the feedback mechanism and of flexibility in case of course correction.
Above mentioned methodologies are core to the strategic plan, however, it has been widely known that strategies tend to fail. Hence it is important to analyze the reason of failures. One of the key reason of failure is the fact that organization goes wrong in the first place itself that what it wants to do? Research suggests that biases in decision making are one of the important reasons for wrong selection of options available for any organization. Biases not only affects the formulation of a strategic plan but also severely affects the strategic implementation. These biases are collectively termed as cognitive biases (Baron, 2007). Cognitive biases are a collective systematic pattern of deviations from rationality. The decision maker tends to make either ‘illogical’ or ‘irrational’ decision or draw inferences which is not rational. Since decision makers are also individuals at the end and like any other individual they tend to formulate their own subjective social reality which is largely based on their perception of the inputs. The subjective social reality tends to overcome the objective inputs while making the decision and determine their behavior. Some of the key cognitive biases are fundamental attribution error, confirmation bias, self-serving bias, framing, hindsight bias etc. (Baron, 2007). Rational planning, has the capability to nullify the impact of cognitive biases while making strategic plans such as which market to enter, which product to be retained in the portfolio, which new product to be launched, what should be the organizational goal etc. since rational planning uses scientific tools and framework and in general it quantify the pay-off of the action. Therefore, strategy as a plan can be augmented and more effective if aided with rational planning.
Another aspect of strategy is not limited to a formulation of vision and mission but also making it analogous to a game of chess which includes maneuvering of existing plan to formulate of counter move against the competitor move. It also includes sending signal to market participants including competitors. Some of these signals include announcing the moves such as making huge investment commitment, the launch of fighter brand, the threat of antitrust suits, deterring a new entrant from entering into segment or market etc. Hence ploy is more of like playing a competitive game. It should be noted that the success of a particular ploy depends on rational decision making based on proper assessment of market and competitors. Any biases may lead to sending an unintended signal and may not work as desired (Heil, 1988).
Further, the strategy has also been defined as consistency in behavior whether or not intended. Though strange, the state has a deeper meaning which means a set of successful approaches merge in a coordinated way to form a pattern of action which may be defined as a strategy. Such a strategy may not be well documented but present in form of a realized pattern which is key to success. One classic example is the strategy of Toyota which is generally termed as Toyota production system. Prima facie, it seems an operational excellence model but it’s satisfying every criterion of being a core competency. It is inimitable or difficult to imitate for Toyota’s competitor as a lot of cultural elements are involved, is valuable since it provides unmatched quality, rare as only Toyota could adopt it and there is a readiness for the same inside the Toyota as it is deeply driven by organizational culture. In this case also recognition of the pattern of action resulting into emergent strategy is critical for any organization. Such recognition and acceptance would come only after rational analysis of situation i.e. under minimal influence of cognitive biases.
Another impact of rational planning is critical to organization while determining its position in market i.e. whether it need to adopt a low cost or product differentiation strategy in a particular market. For example, Ikea, a Swedish furniture retailer, is offering cheap but stylish product by sourcing manufacturing to countries having lower wages and minimizing level of services. Hence Ikea adopted cost leadership strategy. While positioning itself organization need to do a rational assessment about the market size, the needs, and demand of the target segment, competitive landscape, consumer’s perception about the price to performance ratio etc. These assessments need to be based on scientific frameworks such that rational decisions may be taken.
Lastly, the strategy is also about organizational culture i.e. how an organization intended to viewed by its internal stakeholders i.e. its employees. Most organization fails to do this as they could not assess in the beginning that what is the culture of their organization and whether it can be the source of competitive advantage. Organizational culture forms the basis of strategy formulation (Christensen, & Kaufman, 2006). However, it can be identified and included in strategy formulation only if the strategic plan is based on rational frameworks. Decision-based on heuristics and biases often results in a path which either fails to recognize its own organizational culture or does not consider its organizational culture in the strategic roadmap.
Further, it has been observed that all five aspects of the strategy described above are not mutually exclusive and many at times successful companies end up adopting all five aspects of strategy as defined by Mintzberg. It has been validated with the help of analysis of McDonald’s strategy. McDonald’s formulation of growth strategy plan and the corporate plan is the planning aspect of strategy. McDonald’s often sends signals to market which often indicates that it is ready to change its positioning as per the changing consumer preferences. One such signal was made when McDonald’s launched ‘Eat Healthy’ campaign (Mcdonald’s, 2017). This is often regarded as a ploy aspect of strategy. Further, there is a pattern in McDonald’s strategy which is based on standardization of processes and expansion. Further, McDonald’s positioned itself as a cost leader in the space. Lastly, its strategy is always being reflected from the behavior exhibited by its employees. Hence the five P’s of strategy is always being reflected in the rational strategic plan. Further, the game theoretic approach has been adopted while analyzing two similar strategic decision taken by different entities. The Game theoretic approach is considered because it is always based on the fundamental that players involved in the game are rational which means they always prefer more to less. Hence any failure owing to irrationality will be quickly identified by such an approach.
Failure story: Emami Biotech Ltd
Emami Biotech Ltd, an Indian group company of the INR 2200 crore Emami Group, had embarked on INR 400 crore plantation project in the State of Oromia in Ethiopia in 2009. The company intended to take up plantation of bio-fuel crops (jatropha) and other edible and non-edible oil seeds on 100,000 acres of land which had been allotted to Emami Biotech by the Oromia Investment Commission. The land was offered to Emami Biotech on a 45 year renewable lease.
Emami Biotech had engaged Mott McDonald, a reputed engineering and development consultancy, for conducting a feasibility study for the project. Ethiopia was chosen for investment because of availability of labour, contiguous land, congenial business environment and stable law and order situation. It was also felt that the Ethiopian project has a huge potential for the global export market. Once complete the project would have been able to churn out 100,000 tonnes of crude bio-fuel/edible oil per annum. While the bio-fuel was planned to be exported to India for producing bio-diesel, the edible oil produced in Ethiopia was to be used for captive consumption.
The project had initially also envisaged setting up an extraction plant requiring a further investment estimated at about INR 400 crore over a span of five-six years. While Emami Biotech was to bear 30% of the project cost, the remaining funds were to be mobilised from banks and financial institutions (Emami, 2017).
Emami Biotech was already in possession of 27,500 acres of land and work involving a capital outlay of about $25 million or about INR 120 crore had begun on it before Emami decided to pull out from Ethiopia. While it was always known that investment in Ethiopia would face difficulties, Emami was not prepared for the challenges that the following institutional voids in Ethiopia would pose to the company’s plans:
- The Ethiopian government had no stated policy to deal with the relocation of the population displaced from the land that was handed over to Emami. As a result, rights organizations and NGOs have characterized the deals as instances of land grab and have accused the government of forcibly resettling pastoral communities. Further, there was no legal institution to protect Emami from the local population. Hence, Emami had to face the crop damage by local villagers and their cattle and a lack of cooperation from the local administration without an avenue for proper legal recourse
- Limited access to information that was possible given the political set up of Ethiopia led to a failure of due diligence on the part of Emami. As a result, they were caught unawares with regards to the water situation in the land that was allotted to them. The company claims that only half the land initially allotted to Emami was suitable for agriculture, and even that land didn’t have enough water. This was however only found once the company invested $1.5 million in the project, dug several bore wells, and constructed a check dam and realized that the water availability was scarce, at best
- Other factors include the high internal cost of transport, the absence of trained labour, government inefficiencies and the high costs of equipment (Emami, 2017).
Success Story: EXIM Bank
Export-Import (Exim) Bank of India is a financial institution wholly owned by the Government of India, set up by an act of parliament in September 1981. It was set up for providing financial assistance to exporters and importers, and for functioning as the principal financial institution for coordinating the working of institutions engaged in financing export and import of goods and services with a view to promoting the country’s international trade. Africa has been identified as a target by the Exim Bank which has 87 LOCs currently in operation in Africa amounting to US$ 3.78 billion (Exim Bank, 2017).
A huge problem faced by Indian companies, especially infrastructure building companies, in Africa relates to getting government approvals and being assured of payment for services offered. The latter leads to problems of funding and credit for companies that intend to complete projects in Africa. Sensing this, the Exim Bank of India serves to overcome these institutional voids. Exim Bank extends Letter Of Credit to regional development banks and economically strong developing countries on commercial terms (Exim Bank , 2017). This works in the following manner:
- The partner country discusses development priorities with the Indian Mission and a feasible project is identified / developed.
- The Indian Ministry of Finance, Department of Economic Affairs, examines if acceptable from finance/budget angle and conveys approval
- Exim Bank conveys the terms (interest rate & credit period)to the LOC-recipient country and the agreement is finalized
Under the LOC agreement, goods and services for minimum 75% value of the contracts covered under these LOCs must be sourced from India. Also, consultancy services under the project will be sourced from India. In this manner, Indian companies are provided with a chance to do business with African nations in a safe manner such that their business interests are protected from institutional voids by guarantees from both the Indian Government and the recipient country’s Government. Goods and services covered under the LOCs will be free from all kinds of taxes and duties of any nature whatsoever levied in the LOC-recipient country including all corporate/personal/Value added taxes, import/custom duties, special levies and social security contributions for temporary employees deputed by Indian exporters in relation to the project execution in the Recipient countries.
The specific Indian firm to which the contract is awarded is an outcome of a transparent and competitive bidding process. Also, reasons for the recommendation for selection of the Indian company have to be provided in a report to Exim Bank, which finally gives the green signal for the contract. Eligibility of participation in the bidding process is limited to Indian companies registered in India and/or incorporated/established under any law in force in India. Some examples of projects completed are as follows:
- Locomotives and coaches were supplied by the Indian Railways for rehabilitation of Railway in Angola under the LOC of US$ 40 million. This included the modernization and up-gradation of the Angolan coach workshop, the supply of 41 coaches, 3 locomotives, 2 Diesel Multiple Units and pick-up vehicles and buses
- Under the LOC of US$ 27 million to the Govt. of Senegal, Indian company Kirloskar, manufactured, supplied and installed 2394 diesel engine pumps in rice-producing zones of Senegal (Exim Bank , 2017).
The situation Emami and Exim bank faced in Ethiopia that eventually led to Emami’s withdrawal (and the subsequent loss it incurred), and Exim’s continued success can be modeled as the following game:
Game for Emami:
In the above depiction of the game, Nature is an arbitrary player which decides whether the Ethiopian Govt. is capable of handling the relocation of the displaced. So, with probability p, the Ethiopian Govt. is considered capable of handling the disrepute, and with 1-p, it isn’t. Emami’s expected payoff from playing ‘Go’, i.e. setting up the establishment in Ethiopia is 10p-5(1-p)= 15p-5. This payoff exceeds the payoff for ‘No Go’=-2p for all values of p. The main reason for this disparity is that Emami’s expected benefits from a successful establishment would lead to a profit significantly higher in magnitude viz-a-viz a loss from an unsuccessful establishment.
Ideally, Emami wanted a positive payoff from its invested. So, it’s the assessment of p should be at least 1/3, a value at which the expected benefits from successful investment are just undone by potential loss from an unsuccessful investment. Hence, ‘Go’ was a dominant strategy for Emami.as long as its estimate of the Ethipian govt. ability to handle the dispute was greater than 1/3.
This is where information asymmetry crept into the game. Now, the Ethiopian Govt. knew about its capability to settle such a dispute. However, Emami didn’t. It ended up overestimating the govt.’s capability and made a wrong investment. It is important to note that it was in the best interest of a non-capable Ethiopian government not to disclose its true capability to the Indian conglomerate.
In such a situation, where information asymmetry severely lowers the expected payoffs of one player, it is ideal to use the concept of signaling, as we show later.
Game for Exim Bank:
The game is similar for Exim Bank. However, by selecting to deal with only regional development banks and economically strong developing countries, that too on commercial terms, the bank ensures that p is sufficiently high, resulting in the favorable outcome which gives the bank a payoff of 10 in almost all cases.
Signaling Game for information Asymmetry and its application to Emami:
Signaling has been used to overcome information asymmetry: wherein one player has more knowledge than the other player on issues (usually regarding him or any other situation) and can use this disparity to his own advantage. Signaling is the process by which the player who has the extra information is forced to reveal his true self.
As per this game, Emami would ask the government to produce a No Objection Certificate (NOC) from either a good repute NGO or a People’s Rights Organization(PRO) clearly stating that adequate provisions have been made for the resettlement of the displaced.
In the above figure, W is the amount paid by Emami for the contract to the govt. if the govt. produces a certificate. If the govt. fails to furnish one, Emami would pay w. Here, w<W (w=1, W=4). Also, C is the cost of producing a certificate for a non-capable government, and c is the corresponding cost for a capable government. The underlying logic is that it is easier for a capable government to produce such a certificate because it has the trust of the NGOs/ PROs. Conversely, it is difficult for a non-capable govt. to produce such a certificate. Hence, c<C (c=2, C=5). The payoffs for the various cases depicted in the game then become easy to understand.
Here, the Ethiopian Govt. has two choices, either it produces the certificate (Certificate) or it doesn’t (NC). The signalling game is modelled in such a way that it is in the best interest of a capable govt. to produce a certificate and a non-capable government to not produce a certificate. The game works only if the cost of procurement of a certificate C is sufficiently high and overcomes the expected gains by the Govt. from Emami’s investment. Figuratively, W-C should be <0, where W-C is the payoff associated with a non-capable government producing a certificate at cost C but receiving payment W from Emami as it has produced the certificate, and 0 is its payoff from not producing the certificate and consequently Emami not investing.
The Nash-Equilibrium for the above game is (Emami investing if the government produces a certificate and not investing otherwise; A capable government producing a certificate and a non-capable govt. not producing one).
Hence, Emami can blindly invest if the govt. produces a certificate and not invest otherwise.
The game designed above raises an important issue of information asymmetry which often lead to irrational behaviour. In absence of information decision makers tend to get swayed by their cognitive biases and end up taking a decision which they believe is correct. Information asymmetry weakens the rational planning and hence lead to failure of strategic decisions. Hence Strategy should only ever develop from detailed rational planning.
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