I was confused, when I first stumbled over this question, as I wasn‘t aware of 6 specific steps of strategy formulation. However, when looking at my own strategy formulation process, I quickly realised that there definitely are 6 distinct phases.
The 6 steps of strategy formulation are analysing the 5 competitive forces, running a SWOT-analysis, formulating a strategic goal, identifying the strategy, setting policies and guidelines and identifying specific coherent activities.
Please note, that nowhere, I stated coming up with a vision first. You might have one, which is alright. But you don‘t need one to design a good strategy.
Analyse the 5 competitive forces
Every strategy formulation has to start with a clear picture of the environment I operate in. There is a logical reason, why you shouldn‘t start out with formulating a vision, mission and goal. You just cannot know if they are feasible.
Let me put forward an analogy. If you were to have the mission of „finding New York‘s coolest spot“ and you set your goal as „reaching No. 1 Coolness Ave by the 15th next month“, you would never reach it. Why? Because you haven‘t analysed your surroundings and found out that there is no „Coolness Ave“.
I know, it might be a bizarre analogy. But the idea of starting out with a goal, not knowing if it‘s possible to reach strikes me as even weirder. So let‘s look at the well known 5-forces-model first, before we come up with an idea of where to go.
The 5 forces are a concept for analysing external factors that influence a strategy. As you can see, it is not only the competition that you have to deal with. Your strategy is also going to be influenced by the bargaining power of your buyers and suppliers, as well as how big the threat of new market participants or substitute products is.
Threat of new market entrants
Depending on how easy it is, to get into the industry, the threat of new entrants is going to influence your strategy. Generally speaking, the lower the barriers of entry are, the higher will be the competition in the future.
The barriers of entry can be obvious or quite subtle. The following types are typical:
- economies of scale, i.e. car market
- already differentiated products in the market, i.e. beverages
- capital requirements, i.e. banking industry
- Government policy, i.e. regulation
Industry competition
The current competitive situation is the next factor to consider. Here the subject becomes quite complex. Of course, the more competitors there are, the more choice a customer has. However, the market has to be analysed in respect to the following questions:
- Does the market structure support big competitors, or are there structural issues that keep companies from growing past a certain size (like absence of possible scale economies)?
- Are there competitors with a defendable cost advantage, a defendable differentiation or a focus that gives them an advantage?
- Is the market growing, stable, or declining?
- How does value creation for the customer usually work and are there untapped potentials?
This list is by no means complete. If you want to deepen your knowledge, I recommend you go to the source. In that case, the „dean of business strategy“ Michael Porter came up with that framework and published it in 1980. In his book „Competitive Strategy“ he lays out the path for systematically and thoroughly analysing and finding a business strategy. It is one of the most thorough books on the subject that I know.
Threat of substitute products
The alternative to your product or service plays a role as well. It is an option for the customer and therefore can be in the way of charging higher prices.
The fewer alternatives or the more expensive the alternatives are, the better it is for your own industry to earn high returns.
The thing you have to keep in mind is that substitution is hard to detect sometimes. The possible substitutes for Netflix, Disney+ and Amazon are not just TV and YouTube. They also include books, Playstation, cinema, theatre and even sports. It is the view of the customer that counts. And the customer uses Netflix to fill free time and to be entertained. Any option that fits this bill is a possible substitute and can lure away your potential buyer.
Bargaining power of buyers
The bargaining power of your customers determines the potential business success as well. If your company serves big clients and each of them takes up a major part of your revenue, your company is in a sort of captive situation. Big buyers tend to demand big discounts and extras.
Also, legal situations can put the potential buyer in a good bargaining position. The access to information, the economic situation of your buyers and changes in trends and tastes, all play a role in the strength in bargaining with your company.
Bargaining power of suppliers
In this section, you need to analyse the purchasing side of your company. It is basically the same kind of questions than before, just with you on the customer side.
- How big is the share of revenue at your suppliers?
- What information advantage do they have?
- What laws do you have to deal with?
One thing you mustn‘t forget is your employees. They are the suppliers of labour to your company and should be analysed the same way as any other supplier.
All of that industry analysis is going to take a major time commitment. For a small business, it is probably somewhere in the realm of 2-5 days. Of course, it depends on how deep you want to go and how available the information is.
I would like to convince you that it is worth it. If you need arguments, check out my post in „Why is business strategy important?“. I hope there I can make a case for why it is absolutely vital to think strategically.
SWOT-analysis
After the external analysis, the view turns inward. And I mean, that only now it makes sense to do an internal analysis.
SWOT stands for Strength, Weaknesses, Opportunities and Threats. The last two, we ticked off already. But they have to come first, since you don‘t know what a potential weakness in your market is unless you know what the market demands.
Armed with that knowledge, however, you can find corresponding qualities. Here is one example from a strategy I worked on for a customer:
Out of these aspects grew the following thought later on:
A strategic advantage in our market would be to have a sophisticated in-house training system for new and old members of staff. This would allow us to combat three external factors:
1. We would be more efficient at the customer‘s site, as the need for training on the job would be smaller.
2. The quality of our work would rise, allowing us to be noticeably different from our competitors.
3. Hopefully, this way we can lower employee churn – the identified main problem in our industry.
Note that the strategic advantage has to be built up. It wasn’t there from the beginning.
In a complete SWOT analysis, the strategy almost emerges on its own. The reason is that the major market factors usually force some kind of response by the players in the field.
By analysing how to tackle the problems and harness the opportunities, you automatically make choices specific to your situation.
Formulate a strategic goal
After the SWOT analysis, you can turn to formulating a strategic goal. It should be concise and a description of the direction you try to shoot for.
In the example of the hotel cleaning service, it looked like this.
In order to escape the price squeeze of the 2 big customer hotels (90% of revenue), we will focus on medium-sized hotels where our bargaining power is higher. This should allow us to set higher prices to compensate for the increase in costs from trying to differentiate.
(Mind you, this is just one aspect of the strategic goal. In reality it can be longer. In this case, the original had about an A5 page full of content and consisted of three sub goals that were linked.)
Identify the strategy
Here comes the part where you actually lay out your strategy. You outline a general direction in the fields you want to work on. This is the part where the example from the SWOT analysis ties in. Building up a training program helps to deal with a threat and taking advantage of a clear opportunity.
You should aim for as little points as possible. If you can identify directions and actions that deal with more than one issue, you should follow that path. Because, these actions provide you with leverage. It means that you concentrate on a few things, but reach an disproportionate effect.
By the way, the cleaning service had just three areas with a strategic direction.
Of course, strategies can be categorised, especially into Michael Porter‘s three generic strategies. If you would like to read up on Differentiation, my article „When differentiation strategy works best“ might just be for you… 😉
Set policies and guidelines
Out of the identified strategy flows an understanding of what you have to do and what you need to stop doing. This is important, since it will connect your theory with practical business life.
Normally, you can sum up these do‘s and don‘ts in a concise rule that you can apply in your business.
In our example case, the rules looked like this:
- Our marketing and sales activities will only be aimed at hotels with 120 – 200 beds.
- No employee goes to the customer without basic training.
- Every cost position needs to have a reasonable benefit to the company.
Of course, they may look arbitrary to you. But in the case of our hotel cleaning service, they made sense (for the individual position they were in at the time).
This point and the last are straight out of Richard Rumelt‘s work from „Good strategy/Bad Strategy“. It is a book that every business owner needs to read. It brings strategy work down to a highly pragmatic core – absolutely useful!
Identify specific coherent activities
The last part is an exercise in project planning. It is very important to define specific actions and connect them to your guidelines. If you skip this part, it will prevent your strategy from developing any punch.
This is also the most tedious part, since you need to think through (although not to 100%) what actions you have to take in the real world to execute. It always reminded me of project planning, especially when you have one-time-activities in order to set something up.
At the end of this little guide to strategy formulation, I would like to point your attention to my article on what a good strategy has to contain. It complements this post, as it focuses on the things that you need to keep in mind, when writing a strategy.