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Risk, commitment and trade-off

From the previous steps, you have seen that firms have the dilemma of choosing between cost leadership and differentiation.

Jeff Bezos, the CEO of Amazon, is quoted to have said:

There are two kinds of retailers: those folks who work to figure how to charge more, and companies that work to figure how to charge less, and we are going to be the second.

(Jeff Bezos n.d.)

You may not view Amazon as a cost leader but that’s another conversation to be had.

Later on in this programe, we will study how firms who sought to pursue cost leadership and differentiation simultaneously lost market share because they were ‘stuck in the middle’. Why is it imperative to commit to cost leadership or differentiation? Because resources are finite and there are risks in deploying them, as well as commitments that may not easily be reversed when resources are deployed. Therefore, well-managed organisations ‘trade-off’ alternative strategies to lower costs and increase profit margins.

On the one hand, risk in the deployment of resources is a function of two things – uncertainty and impact. Uncertainty is the likelihood of a particular event occurring, and impact is the (often negative) consequence it will have if it does occur.

On the other hand, commitment is the deployment of resources such as personnel, money and organisational time for the purpose of strategy execution. When risk and commitment are considered, organisations are in a position of seeking trade-offs.

A trade-off means forgoing one strategy in favour of another because it is impossible to do everything due to limited resources. For example, Southwest Airlines chose to focus on the domestic US travel market and forfeited opportunities in international destinations. Fortunately, it has been a prudent trade-off.

The paradox of making a commitment by organisations is that it reduces flexibility because resources are locked in and unavailable to alternative strategies. To manage this paradox, organisations take a staggered approach to investment.

For example, several oil companies have acquired small businesses in the renewable energy sector in order to prepare for a carbon-free future while profiting from petroleum-based products that are still mainstream. Even though such a ‘staggered approach’ may prove effective, there is still a need to make a firm commitment because:

  • Without substantial investment of time, money and people, the firm is unable to deliver value that cannot be easily and quickly copied by competitors.
  • Making a substantial commitment galvanises stakeholders on the direction of travel and the place of the organisation within the industry. It may even repel competitors.

In the table below, we outline some of the dilemmas and trade-offs facing organisations including flexibility or commitment, diversification or focus, control or empowerment and global or local responsiveness.

Trade-off On the one hand… But on the other hand…
Flexibility versus commitment Premature commitment (ie, committing too early) can waste resources. Prolonged commitment can lock resources into unproductive areas. Once resources are locked up into one option, you become less flexible to pursue other options. Failure to commit sufficient resources early enough may lead to markets being lost to more adventurous or more committed players who may dare to invest in a much bigger amount than you.
Diversification versus focus Too much reliance on one set of customers or market can render an organisation vulnerable to their whims. By focusing on specific market segment, the firm’s success becomes dependent on this particular market segment. Diversifying into too many businesses or too many markets can make the firm overstretch its resources and focused competitors may become more efficient at serving these markets than you.
Control versus empowerment Rigid organisational control can lead to slow and inefficient decision-making because approval process for ideas may go through many hierarchies in the firm. Flexible control means empowering lower level employees to make decisions and therefore, they can become more innovative and more responsive to customers. Loose controls can lead to agency problems or behaviour that may cause damage to the organisation.
Global versus local responsiveness Producing a global product (same product that can be marketed globally, usually under the same brand name) can lead to cost advantage in terms of economies of scale. A global product may not sell in every country. You may need to customise the product in some way in response to needs of local requirement in each of the market you enter. Customisation of product of course increases costs but it may give you differentiation advantage.

Is it possible to circumvent the paradox of trade-offs? Yes, it is.

Toyota has shown that is possible to bypass the paradox of trade-offs by being a cost leader and differentiator at the same time. For most of Toyota’s mass market cars, it has developed advanced manufacturing processes to lower its production cost and sell at competitive prices. However, as we already know, the trade-off of this is that too much reliance on one set of customers or market can render Toyota vulnerable to their whims. By focusing on a specific mass market, Toyota’s success may become too dependent on the segment.

So what did Toyota do? In 1989, it created a separate luxury vehicle division called Lexus with no branding resemblance of its mass market cars and it has proved a hit in the upscale market alongside Mercedes, BMW and others.

There is a developed field of study called blue ocean strategy that discusses trade-offs in greater detail. The benefit of circumventing the paradox of trade-offs is that it creates new markets or ‘blue oceans’ that had previously been unserved. See the indicated further reading if you want to know more about blue ocean strategy.

Your task

What trade-offs have you had to make in your career or in your company? Discuss in the comments area.

Further reading

Kim, W., and Mauborgne, R. (2015) Blue Ocean Strategy. Massachusetts: Harvard Business School Publishing

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This article is from the free online course:

Strategy as a Process and Measures of Success: An Introduction

Coventry University