Understanding the strategic situation

28/10/2019 ☼ Design ☼ Strategy ☼ Uncertainty ☼ Environment ☼ Resources ☼ Organization ☼ Constraints

Inside and outside the organization; Types of environment; Specialists and generalists; Environmental constraints lead to similarity and difference; Assessing the environment; Internal resources; What makes a resource strategic?; A broader view of the strategic situation; Environmental resources; Internal constraints.

Main take-aways

A basic way to think about an organisation’s strategic situation is to look at what’s inside the organisation and what’s outside it.
What’s outside is conventionally thought of as constraining what the organisation can do (though it can also offer resources to the organisation).
What’s inside is conventionally thought of as resources for the organisation’s work (though it can also constrain the organisation’s actions).
Environments can be classified in different ways: friendly/hostile, stable/dynamic, simple/complex.
Environmental constraints lead to organisational similarity (though there is still room for organisations to work and look different by pursuing different goals or using different strategies).
Internal resources are strategic if they are valuable, rare, inimitable, and non-substitutable.
Strategic analysis requires understanding an organisation’s goals in relation to its strategic situation—the two interact to determine what actions it should take.

Inside and outside the organization

One basic way to think about the strategic situation—the context in which an organization sets goals and chooses actions to achieve them—is to consider what lies outside the organisation and what lies inside it.

Organisational interior: Inside the boundaries of the organisation are the teams, subgroups, processes, informal and formal hierarchies, tangible and intangible assets. These make up the organisation and allow it to do its work.

Organisational environment: Outside the boundaries of the organisation are other competitor companies, markets, suppliers, consumers, laws and regulations, public opinion, the state of technology, the physical/natural environment. These determine what the organisation can do and how it can do it.

The conventional approach is to think of the organisational interior as holding resources, and the organisational environment as imposing constraints.

External constraints

Conventionally, we think about the organisation’s environment as something it must react to because the environment confronts it with forces that determine what it must do to survive.

Types of environment

There are many ways to classify environments. A basic and generalisable classification is to consider whether the environment is:

Friendly or hostile. An environment might be considered friendly if it is structured so that organisations in the environment find it easy to operate and make a supernormal profit. Conversely, if an environment is filled with competitors constantly driving down supernormal profit or legislation (or culture) that makes doing business extremely onerous, it might be considered hostile. Examples: government monopolies tend to operate in relatively friendly environments, while discount retailers tend to operate in relatively hostile environments;
Stable or dynamic. An environment is relatively stable if it changes only infrequently (perhaps because its core technology seldom changes or it is not attractive for new entrants). Conversely, an environment where core technologies are continually updated or developed, or where new competitors continually enter, is relatively dynamic. Examples: commodity businesses tend to operate in relatively stable environments, while consumer technology and cutting-edge science businesses tend to operate in relatively dynamic environments;
Simple or complex. An environment is relatively simple if businesses in it don’t need to navigate many details (e.g., regulations or technology) to do their work. Conversely, an environment is relatively complex if it has profuse and interacting regulations and draws on many interdependent technologies. Examples: low-tech extraction and manufacturing businesses tend to operate in relatively simple environments, while high-tech businesses or those operating in highly regulated industries such as healthcare tend to operate in relatively complex environments.
Certain or uncertain. Covered last week.

Note that these are

Continuous. An environment will not be absolutely stable or dynamic, but will instead be somewhere on a continuum between being stable and being dynamic;
Relative. An environment is more dynamic or friendlier compared to other environments;
Combinatorial. Environments can be any blend of these properties. A friendly, simple, stable business environment could be quite nice to operate in—but the environment could also be hostile, dynamic, and complex.

Survival and success depend on fit with the environment

The right strategy for the organisation depends on the specifics of the environment. Organisations that don’t adopt the right strategy will be selected out (ie, will not survive). Management’s role is to evaluate the environment and pick the right strategy.

Specialists and generalists

Depending on the nature of the environment, organisations can design themselves to become either specialists or generalists. Specialist organisations are relatively more efficient at using their resources to address the specific constraints of their environment—they are efficient because they have relatively less organisational slack (unused capacity). In contrast, generalist organisations hold relatively more unused resources; this is inefficient but the unused resources can be applied to responding when the environment changes. Stable and predictable environments tend to favour specialists, while dynamic and unpredictable ones tend to favour generalists

Environmental constraints lead to similarity and difference

Most organisations that face the same environment will face similar constraints and pressures—they often look and work in similar ways. The three main sources of pressure for similarity are:

Regulations. These are formal rules or laws which organisations in the environment must conform to. Example: Banks all require multiple forms of ID for new customers due to AML and KYC regulations;
Norms. These are informal rules which organisations in the environment must conform to. Example: Most consumer banks issue chequebooks and have physical branches with bank tellers;
Competitive pressures. These are things organisations do because their competitors do them. Example: Most consumer banks have basically useless mobile apps.

However, this does not mean that all organisations face exactly the same environment, nor that they all look and work the same way. In large part this is because organisations in the same environment can pursue the same goal with different strategies (based on different resources) or pursue different goals with different strategies.

Internal resources

Conventionally, we think of an organisation as containing resources. These resources are broadly defined. They include not only obvious physical resources (like physical materials, physical equipment, buildings and real estate) and obvious non-physical resources (like patents) but also harder-to-classify resources such as employee relationships, knowledge, brand equity, customer relationships, and supplier relationships.

Resources, capabilities, resource bundles

Conventional strategy distinguishes between three sub-types of resources which are related to each other.

Resources [nouns]: These can be tangible or intangible, but all are things that stuff can be done with. Examples include buildings, equipment, brand, and reputation.
Capabilities [verbs]: These can be tangible or intangible, but all are things that the organisation knows how to do. Examples include innovating, adapting, injection moulding, and high-precision tooling.
Resource bundles: These are interconnected sets of resources and capabilities that are often cross-functional. Examples include: Owning precision milling machines and a workshop facility in which to locate them, combined with having a team of experienced machinists who know how to do high-precision tooling. (Resources bundles are also known as dynamic capabilities.)

What makes a resource strategic?

A resource (= resource, capability, or resource bundle) is more likely to be strategically valuable if it is

Valuable: The resource is worth something.
Rare: The resource is uncommon—ideally unique.

It is more sustainably (i.e., defensibly) strategic if it is also

Inimitable: The resource cannot be duplicated or imitated.
Non-substitutable: The resource cannot be replaced by a different resource that does the same thing.

Good strategy is about developing and using the right resources for the constraints faced.

A broader view of resources and constraints

While the environment often acts as a constraint, it can also offer resources—just as the organisation often contains resources but can also constrain itself.

Environmental resources

The environment can act as a resource in several ways, all of which work by reducing an organisation’s need to build internal resources:

Provides access to ecosystems of supply. Example: Internet businesses used to have to build their own server farms at significant cost; the emergence of an ecosystem of suppliers of on-demand server capacity (such as Amazon Web Services) now makes it possible for an internet business to start up with a much smaller capital expenditure.
Provides access to technical knowledge platforms. Example: University researchers publish basic and applied research in journals; this allows businesses to use the research freely in developing products and services (in contrast to research that is kept secret and unusable by others, or research that is patented and thus made public but not freely usable by others).
Creates a hospitable environment for an organisation’s particular configuration of resources. Example: Healthcare industry regulations that mandate the use of electronic medical records privilege incumbents that have already invested in EMR technology (while disadvantaging new entrants or incumbents who have not).

An organisation can act to modify its environment to offer more resources (or presents fewer constraints). Examples include lobbying for self-benefiting regulation (e.g., FAANG lobbying for net neutrality) and investing in creating supplier/consumer ecosystems (e.g., Facebook’s new Libra governance consortium).

Internal constraints

An organisation can also be self-constraining in several ways:

Existing organisational structure (including hierarchy and ways of working) prevent actions. Example: A consumer packaged goods company organised by geographical region wants to develop a new product that brings together expertise from R&D teams working in different geographies, but this is impossible because the vice-presidents of the regional divisions intensely dislike each other.
Existing investments (including investments in resources/capabilities) prevent actions. Example: A pharmaceutical company that focuses on injectable anti-cancer drugs wants to diversify by developing orally consumed stomach ulcer drugs, but the equipment for developing injectable cancer drugs cannot be used for developing oral stomach ulcer drugs (note: massive oversimplification).
Existing stakeholders prevent actions. Example: An automobile manufacturer wants to become more profitable by reducing employee numbers and closing a few factories, but the employee union calls a strike that prevents the leadership team from taking those actions.

Some internal constraints can be mitigated by organisational action. Examples include re-structuring the organisation (like GE has done), divesting certain investments (like the We Company is currently doing), or negotiation (like GM keeps having to do with the Union of Automotive Workers).

Assessing the strategic situation

To assess an organisation’s strategic situation, consider what relevant resources and constraints it faces (whether from outside the organisation or inside the organisation). When considering its constraints, think about whether they are fixed or changeable. When considering its resources, think about the extent to which they are valuable, rare, inimitable, and non-substitutable.

Goals interact with situation to determine action

Before an organisation’s strategy (the actions it has chosen to achieve its goals) can be evaluated, its goals and strategic situation must first be clearly understood. The organisation’s strategic situation (i.e., the resources and constraints it faces) determines what actions are available to be taken. The organisation’s strategic situation and its goals in combination determine which of those actions should be taken. This interaction between goals, situation, and action is the underlying framework for understanding strategy.

This is an extremely simplified overview written for undergraduates. A full reading list (for my PhD seminar in strategy and design) is available here.