STRATEGY FORMULATION IN SMALL BUSINESS: A
                     CONCEPTUAL FRAMEWORK
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market, group of customers, product or service. The firm pursuing a focus strategy creates a competitive advantage in a
na...
Step 3 - Assessing Your Capabilities: The Situation Audit. This step involves assessing the firm's real capacity to carry
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(13) Porter, M., "From Competitive Advantage to Corporate Strategy", Harvard Business Review, (May-June 1989),
pp. 43-59.
...
Product or service (quality, techniques, scope, position, innovation, facilities, experience) Marketing (sales force,
dist...
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STRATEGY FORMULATION IN SMALL BUSINESS: A CONCEPTUAL FRAMEWORK

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Transcript of "STRATEGY FORMULATION IN SMALL BUSINESS: A CONCEPTUAL FRAMEWORK"

  1. 1. STRATEGY FORMULATION IN SMALL BUSINESS: A CONCEPTUAL FRAMEWORK A.B. Ibrahim, Ph.D., Concordia University ABSTRACT There are many sophisticated concepts of strategy formulation offered in the strategy literature. However, the large majority hold little promise for small firms. This research is devoted to exploring the concept of strategy in small business. In particular, this research intends to, first suggest a model of strategy formulation in small entrepreneurial firms, second discuss different strategic directions relevant to small business that has been described in the strategy literature and finally offer some guidelines on how to develop a strategy for the small business. The Concept of Strategy Hofer and Schendel (1) define strategy as a pattern of objectives, purposes or goals defining what type of business you are in, or should be in. Michael Porter (2) distinguishes between two types of strategy: competitive and corporate strategy. Competitive or business strategy refers to the distinctive competence of the firm. Corporate strategy on the other hand refers to the firm's mission and what business the firm should be in. Strategy Formulation in Small Entrepreneurial Firms There are a number of factors which shape the formulation of strategy in the small business. The firm's external environment, including economic trends, industry structure and competition is important in deciding what course of action the organization should pursue. The internal capacity of the organization is an equally important factor in shaping the strategic decision, including the small firm's resources, skills, strengths and weaknesses. In general, its distinctive competence. However, the internal and external capabilities of the organization are not the only ingredients in the small business strategic decision making process. Entrepreneurs and small business managers are heavily influenced by what they personally want to achieve. In other words, the internal and external capabilities of the small firm is filtered by the entrepreneur's perception as well as his personality, values and expectations. The following model (see Figure 1) describes the strategy formulation process in small business. As can be shown in the figure, the strategic decision is a choice of the entrepreneur or the manager of the small firm. Therefore one way to study strategy formulation in small business is to study the entrepreneur, his personality, values and motivation (3). Henry Mintzberg (4) tracked strategy formulation of a retail chain over a period of 60 years. He found that strategy in the entrepreneurial mode tended to be more intuitive, based on the entrepreneur's judgment, wisdom and vision. Strategic Directions for Small Business There are a number of strategic directions in the strategy literature that could be of greater help to entrepreneurs and small business managers. Let us discuss each briefly. Porter Generic Strategy. Michael Porter (5) identified three types of generic strategies that can be pursued by almost any organization. These strategies help the organization achieve, build, defend and sustain its competitive advantage. A firm builds competitive. advantage by such different means as cost leadership, superior product and technology, quality and reliability of service. Studies have shown that small firms must build competitive advantages to compete effectively in the market place. For example, C.R. Stoner (6) studied areas of distinctive competence for small firms, and the extent to which they form a competitive advantage. The common areas of distinctive competence identified in the study include experience and knowledge, uniqueness of product or service, better than average service, location, low cost and price, quality of product, variety of products, friendly atmosphere, reputation and unique method of marketing. The first generic strategy identified by Porter (7) is focus (niche) strategy. This involves concentrating on a specific
  2. 2. market, group of customers, product or service. The firm pursuing a focus strategy creates a competitive advantage in a narrow and well defined niche to avoid head-on collision with large competitors. A study by D. Watkin (8) has shown that focus strategy is very effective for small firms. The second generic strategy described by Porter (9) is cost leadership. This strategy implies that the firm intends to be a low-cost producer. Thus this strategy stresses cost efficiency which can be achieved by economies of scale, experience curve and capacity utilization. Indeed cost efficiency is a strong competitive advantage if the small firm is able to sustain it over a long period of time. This requires an indepth study of the small firm's cost structure as well as an efficient cost control system. In a recent study, E. Hughes (10) found that the use of process technologies (improvement. in the manufacturing process rather than research on new product development) is of little risk for small companies and results in reducing cost and thus building a strong competitive advantage. The third generic strategy is differentiation which involves offering a unique product or service that allows the small firm to charge a premium price. A small business can differentiate its product or service by such means as improving product design, features, appearance, reliability, durability, quality, faster or free maintenance and repair service and warranty. A study by Cooper, Gary and Woo (11) found that differentiation strategy is as effective as a niche type strategy in small firms. This was confirmed by Sandberg and Hofer (12) who reported that differentiation type strategy could be more effective than focus type strategy. Miles and Snow Typology. Miles and Snow's (13) classic research identified three types of strategy that may be effective for a small business to pursue. These are the defender, the prospector and the analyzer. The defender type involves developing a narrow product/market niche and erects barriers (i.e., competitive advantages) to protect it. In this type, the firm does not do any environmental scanning in search of windows of opportunities. The owner/manager exercises a tight control over the firm and a high degree of cost efficiency. Unlike the defender type, the prospector is constantly scanning the environment for new opportunities, be it a new product or service or a new market. In order to be able to scan the environment, prospectors are highly flexible in every aspect of operation. Indeed R&D activities are extremely important. Finally, the analyzer type is a combination of a defender and a prospector. That is, while part of the organization is defending its niche, the other part is scanning for new opportunities. A study by Davig (14) reported that small firms pursuing either defender or prospector types achieve better performance compared with analyzer types. Rugman and Verbeke (15) found that prospector-type strategy is the most pursued strategy followed by the defender type. The authors concluded that Miles and Snow's strategies are more appropriate for small business that Porter's generic-type strategies. Stages of Growth. The small firm may also pursue a strategy based on industry stage of growth (growth, maturity, decline). Chaganti (16) found growth stage industries to be more attractive for small firms simply because the learning curve presents an opportunity for the small firm to build a competitive advantage. Chaganti (17) also reported that differentiation-type strategy is more effective for the small firm during decline stage of industries. Developing- a Strategic Direction for the Small Business The following is a step-by-step approach to developing an effective strategy for the small business. Step 1 - Setting Your Objectives. The first step is to define clearly your objectives or what you want to achieve. That sounds almost patronizing, however a large number of entrepreneurs and small business managers do not have a clear idea of what they want to achieve. For some entrepreneurs, it is maximizing their profit and/or a large market share. For others, it is building long-term security, a legacy for their families, or even acting out a fantasy. Indeed this step may take some soul searching, but in the process can whittle many fuzzy and unachievable objectives. Step 2 - Defining Your Mission. The second step in developing a strategic direction is to define what kind of business you should be in. Drucker (18) noted that the key question for small business is who they are or what their mission in the business is.
  3. 3. Step 3 - Assessing Your Capabilities: The Situation Audit. This step involves assessing the firm's real capacity to carry out the intended mission successfully. The situation audit allows the entrepreneur or manager to assess the internal and external capabilities of the small business. The internal assessment includes assessing the firm's strengths and weaknesses in different functional areas such as marketing, production, accounting and general management. The external assessment includes scanning the environment for windows of opportunities or areas of threats. Step 4 - Selecting a Strategic Direction. Having identified your objectives, defined your mission and assessed your capabilities, you should be able to identify different strategies, be it a niche strategy or cost leadership. To select an appropriate strategy, Rumelt (19) suggested the following criteria. First, the strategy must be internally consistent. Second, it must provide a fit between the firm and its environment. Third, the strategy must be feasible in light of the firm's resources. Figure 2 is a strategic alternative matrix that allows you to position your firm strategically. Figure 3 is a comprehensive checklist for developing strategy in the small business. SUMMARY We have attempted in this research to explore the concept of strategy formulation in the small entrepreneurial firm. A model of strategy formulation was offered. The model focuses on the entrepreneur's perception, personality and values. We have also attempted to provide a literature review of different strategic directions available to small business. Finally some guidelines for entrepreneurs and small business managers on how to develop a strategy for small business were offered. REFERENCES (1) Chaganti, R., "Small Business Strategies in Different Industry Growth Environments", Journal of Small Business Management, 25, 3, (July 1987), pp. 52- 59. (2) Chaganti, R., 1987. (3) Cooper, A. , W. Gary and C. Woo, "Strategies of High Performing New and Small Firms: A Re-examination of the Niche Concept", Journal of Business Venturing, (January 1986), pp. 247-260. (4) Davig, W., "Business in Smaller Manufacturing Firms", Journal of Small Business Management, (January 1986), pp. 39-47. (5) Drucker, Peter F., Management: Tasks, Responsibilities, Practices, p. 100, (New York: Harper & Row, Publishers, 1973). (6) Hofer, C.W. and D. Schendel, Strategy Formulation: Analytical Concepts, (St. Paul, MN, West Publishing, 1978). (7) Hughes, E., "Responding to Changes in Process Technology: Strategies for the Small Business", Journal of Small Business Management, (January 1984), pp. 9-15. (8) Ibrahim, A.B. and J. Kelly, "Leadership Style at the Policy Level", Journal of General Management, 11, 3 (Spring 1986), pp. 3645. (9) Miles, Raymond and Charles Snow, Organizational Structure and Process, (New York: McGraw Hill, 1978). (10) Mintzberg, Henry and James Waters, "Tracking Strategy in an Entrepreneurial Firm", Academy of Management Journal, 25, 3, 1982, pp. 465-499. (11) Porter, M., Competitive Strategy, Free Press, 1980. (12) Porter, M., Competitive Strategy, Free Press, 1980.
  4. 4. (13) Porter, M., "From Competitive Advantage to Corporate Strategy", Harvard Business Review, (May-June 1989), pp. 43-59. (14) Porter, M.E., Competitive Strategy, Free Press, 1980. (15) Rugman, A., and A. Verbeke, "Does Competitive Strategy Work for Small Business?", Journal of Small Business and Entrepreneurship, 5, 3, (Winter 1988), pp. 45-49. (16) Rumelt, Richard, "Evaluation of Strategy: Theory and Models", in Dan Schendel and Charles Hofer (eds.), Strategic Management: A New View of Business Policy and Planning, (Boston: Little Brown, 1979). (17) Sandberg, W., and C. Hofer, "Improving New Venture Performance: The Role of Strategy, Industry Structure and the Entrepreneur", Journal of Business Venturing, (May 1987), pp. 5-28. (18) Stoner, C.R., "Distinctive Competence and Competitive Advantage", Journal of Small Business Management, (April 1987), pp. 33-39. (19) Watkin, D., "Toward a Competitive Advantage: A Focus Strategy for Small Retailers", Journal of Small Business Management, (January 1986), pp. 9-15. FIGURE 1 STRATEGY FORMULATION IN SMALL ENTREPRENEURIAL FIRMS The Small Business Strategic Thinking Strategy Formulation Capabilities ÉÍÍÍÍÍÍÍÍÍÍÍÍÍÍ» The Small Business º Filter º External Capabilities º º º ========== º º Personality º====> Strategic Decision The Small Business º Values º Internal Capabilities º Motivation º º Gut Feeling º ÈÍÍÍÍÍÍÍÍÍÍÍÍÍͼ FIGURE 2 STRATEGIC ALTERNATIVES MATRIX Attractive Less Attractive ÉÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍËÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍ» Hi º Exploit ºScan º º perfect niche ºfor other windows º Distinctive º ºof opportunity º Competence ÌÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÎÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍ͹ º Build º º Lo º competitive º Exit =========> º º advantage º º ÈÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÊÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍÍͼ Adapted from A.B. Ibrahim & W. Ellis, Entrepreneurship and Small Business Management: Text, Readings and Cases, Dubuque, Iowa: Kendall/Hunt Publishing Company, 1990. FIGURE 3 STRATEGY DEVELOPMENT CHECKLIST FOR SMALL BUSINESS What are your objectives? What business are you in? What are your own strengths and weaknesses? Do a situation audit analysis. What are your competitive advantages? What are the alternative strategies available to you? Rank your objectives from 1 to 6 (with 1 the most important, 6 the least important). Define your mission. Do a self assessment of your own strengths and weaknesses taking into consideration your lifestyle. Internal Analysis: Identify strengths and weaknesses in areas such as:
  5. 5. Product or service (quality, techniques, scope, position, innovation, facilities, experience) Marketing (sales force, distribution network, customer service, knowledge of consumer needs, promotion, pricing, segments) Human Resources (skills, training, attitudes, compensation). Financial (growth pattern, cash-flow, ROI) Accounting (record system, cost system, control system) External Analysis: Identify opportunities and threats in areas such as: Competition (competitor intelligence, size UP competitors in terms of product or service quality, dealership, resources) Customer (needs and wants, potential gaps) Socio-political (social changes, political and economic changes). Based on the situation audit analysis identify your area(s) of distinctive competence (high to low), i.e.: Product quality Cost advantage Location Customer service Identify and assess different strategic directions that are available to you based on all of the above analysis. Then select the strategy that is most appropriate to your situation.

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