The Structure of Strategy 17

The Structure of Strategy

John Kay

This article takes a view of strategy which disputes the common distinctions between
formulation and implementation, and between programmed and adaptive strategies. It
argues that corporate success derives from a competitive advantage which is based
on distinctive capabilities, which is most often derived from the unique character of a
firm's relationships with its suppliers, customers or employees, and which is precisely
identified and applied to relevant markets. Strategy is that process.

In 1986 I was offered the opportunity, and substantial resources, to

answer the question, 'What are the origins of industrial success?' There
are, perhaps, more important questions, but not many, and that was
certainly the most important question I felt in any way equipped to try
to answer. So I accepted the challenge.
It was obvious that there was no shortage of data. Every corporation
is required to file detailed returns of its activities. In all Western
economies there are several journals which track the performance and
activities of leading companies. Case studies, business histories and
business biographies describe how decisions were made and problems
overcome. I began to understand that what was needed was not to collect
new information, but to establish a framework for understanding what
was already known.
There were those who told me that the task I had set myself could not
be done, or was not worth doing. Business problems were too complex
to be susceptible to the use of analytic techniques. Every situation was "It might be true
unique and there could be no valid generalisations. It had even been that there can be
argued by some (as in Abernathy and Hayes, 1980) that the attempt to no valid generali-
sations about
apply analytic methods to business issues is at the heart of Western
business, and
economic decline. that there can be
It might be true that there can be no valid generalisations about no general the-
business, and that there can be no general theories of the origins of ories of the
origins of corpor-
corporate success or failure. But it does not seem very likely that it is
ate success or
true. It is not just that similar observations were made ahead of much failure. But it
greater leaps in scientific knowledge. How could we hope to understand does not seem
something so complex, and so subject to change, as the motion of the very likely that it
planets or the makeup of genetic material? is true."

Vol. 4, NO.2,pp. 17-37 Business Strategy Review Summer 1993

18 John Kay

The strategy of the firm is the match between its internal capabilities
and its external relationships. It describes how it responds to its sup-
pliers, its customers, its competitors, and the social and economic envi-
ronment within which it operates. These aspects of management activity
are the subject of strategy. Did it make sense for Benetton, an Italian
knitwear manufacturer, to move into retailing, and was it right to decide
to franchise most of its shops to individual entrepreneurs? Should
Saatchi & Saatchi have attempted to build a global advertising business?
What segment of the car market was most appropriate for BMW? These
are typical issues of corporate strategy. Corporate strategy is concerned
with the firm's choice of business, markets and activities.
Should Eurotunnel offer a premium service or use its low operating
costs to cut prices? How should Honda have approached the US motor
cycle market? Faced with three different standards for high definition
television, and a market potentially worth tens of billions of pounds, what
stance should a television manufacturer adopt? What will be the future
of European airlines as deregulation progresses? These are typical
issues of business, or competitive, strategy. Competitive strategy is
concerned with the firm's position relative to its competitors in the
markets which it has chosen.
On the face of it, these are issues which respond to analytic tools, and
if analysis has failed to offer at least partial answers it is because it is bad
analysis, not because the objective is misconceived. The analysis of
strategy uses our experience of the past to develop concepts, tools, data
and models which will illuminate these decisions in future. Taking
corporate and business strategy together, we learn why some firms
succeed and others fail. Why did EM1 fail to profit from its body scanner
while Glaxo succeeded brilliantly in marketing its anti-ulcer drug, Zan-
tac? Why has Philips earned so little from its record of innovation? Why
has Marks & Spencer gone from strength to strength when so many other
retailers have enjoyed spectacular, but purely transitory, success? What
are the origins of corporate success?

What is Success?
iiif
I asked what One paradox was immediately apparent in my pursuit of the origins of
was meant by corporate success. If I asked what was meant by corporate success, many
sue- different answers were proposed. Some people ernphasised size and
cess, many differ-
ent answers
market share, others stressed profitability and returns to shareholders.
were proposed." Some people looked to technical efficiency and innovative capability.
Others stressed the reputation that companies enjoyed among their
customers and employees, and in the wider business community.

Business Strategy Review Summer 1993

 The Structure of Strategy 19

Yet this disagreement was hardly reflected at all in disagreement "Yet this disagree-
about which companies were successful. Whatever their criteria of ment was
reflected at all in
success, everyone seemed to point to the same companies - to Matsushita disagreement
and to Hewlett-Packard, to Glaxo and to Benetton, to BMW and to about which
Marks & Spencer. I formed the view that the achievement of any paniesweresuc-
company is measured by its ability to add value - to create an output cessful."
which is worth more than the cost of the inputs which it uses. These
different opinions on how success should be measured were partly the
result of disagreement about how added value was created, but rather
more the product of different views as to how, once created, added value
should be used. Successful companies, and successful economies, vary
in the relative emphasis to be given to returns to shareholders, the
maximisation of profits, and the development of the business. Different
firms, and different business cultures, gave different weights to these
purposes. But the underlying objective of adding value was common to
all.
I began by asking the managers of successful companies to explain the
sources of their success. They told me that success depended on pro-
ducing the right product at the right price at the right time. It was
essential to know the market, to motivate employees, to demand high
standards of suppliers and distributors. I recognised that all these things
were true, but those who emphasised themwere describing their success,
not explaining it. There was much that had been written on strategic
management. But stripped of rhetoric, most strategy texts offered
checklists of issues that senior executives needed to address in conside-
ring the future of their business. That literature posed questions but
yielded few answers.
Economists had studied the functioning of industry, but their con-
cerns were mostly with public policy, not business policy, and I was sure
that industrial success was founded on the behaviour of firms, not on the
decisions of governments. Sociologists had studied the functioning of "thereare no
recipes, and
organisations, but only a few had matched the characteristics of the firm
generic
to the economic environment that determined its competitive perfor- strategies, for
mance. Corporate suc-
I came to see that it was that match between the capabilities of the cess. There can-
not be, because
organisation and the challenges it faced which was the most important if there were their
issue in understanding corporate success and corporate failure. There general adoption
are no recipes, and generic strategies, for corporate success. There would eliminate
cannot be, because if there were their general adoption would eliminate any competitive
any competitive advantage which might be derived. The foundations of advantage which
might be
corporate success are unique to each successful company. derived."

Business Strategy Review Summer 1993

20 JohnKay

The uniqueness is a product of the firm's contracts and relationships.

I see the firm as a set of relationships between its various stakeholders
- employees, customers, investors, shareholders. The successful firm is
one which creates a distinctive character in these relationships and which
operates in an environment which maximises the value of that distinc-
tiveness. Two well known companies, BMW and Honda, illustrate how
these form the basis of an effective strategy, and how that strategy
contributes to corporate success.

Few who drive a BMW car know what the initials stand for, or realise
that the distinctive blue and white propeller badge reproduces the
colours of the state flag of the State of Bavaria. The Bayerische Motoren
Werke were established during the first world war. They specialised in
the manufacture of engines. The company subsequently diversified into
what are now its two principal product ranges: automobiles and motor
cycles. Today BMW is one of Germany's largest and most successful
companies.
BMW cars are not the most powerful, or the most reliable, or the most
luxurious on the market, although they score well against all these
criteria. No one has ever suggested that they are cheap, even for the high
level of specification that most models offer. Although BMW rightly
emphasises the quality and advanced nature of its technology, its pro-
ducts are not exceptionally innovative. The design of the company's cars
is conventional and the styling of its models is decidedly traditional.
The achievements of BMW are built on two closely associated factors.
The company achieves a higher quality of engineering than is usual in
production cars. While most car assembly has now been taken over by
robots or workers from low wage economies, BMW maintains a skilled
German labour force. The company benefits, as many German firms do,
from an educational system which gives basic technical skills to an
unusually high proportion of the population. Its reputation has followed
from these substantial achievements. In this, BMW is representative of
much of German manufacturing industry.
"BMWs success Yet BMW's success was neither easy nor certain (Monnich, 1989,
was neither easy 1991). In 1945, the company was Germany's leading manufacturer of
nor certain." aeroengines. Its primary market and its capital equipment were both in
ruins. Its principal factory at Eisenach was across the border in the
Soviet occupation zone. While German recovery through the 1950s
occurred at a pace which attracted the title of economic miracle, BMW
did not prosper. Uncertain of its future, the company emphasised

Business Strategy Review Summer 1993

 The Structure of Strategy 21

automobiles but its products ranged from tiny bubble cars, manufac- “In 1959, the firm
tured under license, to limousines. In 1959, the firm faced bankruptcy faced bankruptcy
and a rescue by Mercedes seemed its only hope of survival. and a rescue by
Instead, BMW found a powerful shareholder - Herbert Quandt - who Mercedes
seemed its only
perceived the company’s inherent strengths. The turning point came hope of survival.”
when the firm identified a market which most effectively exploited its
capabilities - the market for high-performance saloon cars, which has
since become almost synonymous with BMW. The BMW 1500, laun-
ched in 1961, established a reputation for engineering quality in the
BMW automobile brand. The brand in turn acquired a distinctive
identity as a symbol for young, affluent European professionals. That
combination - a system of production which gives the company a par-
ticular advantage in its chosen market segment, a worldwide reputation
for product quality, and a brand which immediately identifies the aims
and aspirations of its customers - continues to make BMW one of the
most profitable automobile manufacturers in the world.
Today, the BMW business is structured to maximise these advant-
ages. Retail margins on BMW cars are relatively high. The company
maintains tight control over its distribution network. This control sup-
ports the brand image and also aids market segmentation. BMW cars
are positioned differently and priced very differently in the various
national markets. The same tight control is reflected in BMW’s rela-
tionships with suppliers, who mostly have continuing long associations
with the company. BMW’s activities are focused almost exclusively on
two product ranges - high performance saloon cars and motor bikes -
which reflect its competitive strengths. The company also uses the
brand to support a range of motoring accessories.
BMW is a company with a well-executed strategy. It is a company
which came - after several false starts - to recognise its distinctive “BMW came -
after several false
capabilities and choose the market, and subsequently markets, which starts - to recog-
realised its full potential. Its dealings with its suppliers and distributors, nise its distinc-
its pricing approach, its branding and advertising strategies, are all built tive capabilities
around that recognition and these choices. There was no master plan, and choose the
no single vision which took BMW from where it was in 1959 to where it market, and sub-
sequently rnar-
is today. There was a group within the company which believed strongly kets, which
that a model like the 1500 was the firm’s main hope of survival. There realised its full
were other views, other options. No one had more than partial insight potential.
into what the future would hold. But BMW’s success was no accident
either.

Business Strategy Review Summer 1993

22 JohnKay

Honda
Honda's redefinition of the US motor cycle market is a classic case in
corporate strategy (HBS, 1978). Motor bikes in the US in the 1950s were
associated with a subculture now best recalled through movies, leather
jackets, the smell of oil, and teenage rebellion. In 1964, five years after
its entry into the United States, one in three motor cycles sold there were
"There are two Hondas. The best selling product was a 50 cc supercub, marketed under
views of this
achievement. In
the slogan, 'You meet the nicest people on a Honda.'
one, Honda's There are two views of this achievement. In one, Honda's strategy
strategy was an was an archetype of Japanese penetration of Western markets. The
archetype of aggressive pursuit of domestic volume established a low cost base for
Japanese pene-
tration of Western
expansion overseas. This was the conclusion of a Boston Consulting
markets." Group study for the British government (BCG, 1975). A rather different
account was given by Richard Pascale, who went to Tokyo to interview
' A rather different
the elderly Japanese who had brought the first Honda machines to the
account was United States. As they recalled it, Honda had aimed to secure a modest
given by Richard share of the established US motor cycle market.
Pascale, who
went to Tokyo." "Mr Honda was especially confident of the 250 cc and 305 cc
machines. The shape of the handlebar on these larger machines
looked like the eyebrows of Buddha, which h e felt was a strong
selling point,"
(Pascale, 1984: 54)

These hopes were not realised. The eyebrows of Buddha had little
attraction for the leather-jacketed Marlon Brando.
"We dropped in on motor cycle dealers who treated us discourt-
eously and, in addition, gave the general impression of being
motor cycle enthusiasts who, secondarily, were in business."
(Pascale, 1984: 54)

The first supercubs exported to the United States were used by Honda
employees for their own personal transport around the concrete wastes
of Los Angeles. It was only when these caught the attention of a Sears
buyer and the larger machines started to show reliability problems that
Honda put its efforts behind the 50 cc machines. The 'nicest people'
slogan was invented by a University of California undergraduate.
Neither of these accounts is entirely convincing. The BCG account
is an expression of the near paranoia created for many Westerners by
Japanese achievement. But Pascale's suggestion that Honda's success
was simply the result of good fortune would be more persuasive if the

Business Strategy Review Summer 1993

 The Structure of Strategy 23

company had not been blessed by such good fortune quite so often in
the course of its spectacular rise. The ’eyebrows of Buddha’ are all too
reminiscent of the South Sea island girls who teased Margaret Mead with
ever more extravagant accounts of their sexual exploits.
We shall never know the extent to which Honda’s success was truly
“Weshall never
the result of chance or rational calculation. But while knowing may be
know the extent to
important to the business historian, it is of little significance to the which Honda’s
corporate strategist. Quinn, Minzberg and James (1988) - in what is success was truly
perhaps the best of recent strategy texts - pose for their readers the the result of
question (p. 81)’ ’Ask yourself while reading these accounts, how the chance or rational
calculation. But
strategic behaviour of the British motor cycle manufacturers who re- while knowing
ceived the BCG report might have differed if they had instead received may be important
Pascale’s second story.’ The correct answer, of course, is ’Not at all.’ to the business
Suppose it were shown conclusively that Honda’s success was the result historian, it is of
of purest chance. It would not then follow that the right approach for little significance
to the corporate
British firms was to wait for similar good fortune to fall on them. This strategist.
‘I

was what they in fact did, with notable lack of success.

Honda effected a brilliantly successful market entry. Like all success-
ful strategies, it was based on a mixture of calculation and opportunism,
of vision and experiment. Like all successful corporate strategies, it was
centred on Honda’s distinctive capability - an established capacity to
produce an innovative but simple, low-cost product. Its realisation
depended on a successful competitive strategy, which made full use of
segmentation and involved the creation of a distinctive distribution
network which bypassed the traditional retail outlets of the enthusiasts.
The lessons we can learn from that strategy are much the same whether
Honda conceived it by grand design or stumbled on it by accident.

The Nature of Strategy

The issues that BMW and Honda handled so successfully are the central
questions of strategy. BMW and Honda had to consider what markets
“A strategy - like
to enter, how to position their products within these markets, how to that of BMW or
build relationships with dealers and component manufacturers. The Honda - is a se-
subject of strategy analyses the firm’s relationships with its environment, quence of united
and a business strategy is a scheme for handling these relationships. events which
Such a scheme may be articulated, or implicit, pre-programmed, or amounts to a
coherent pattern
emergent. A strategy - like that of BMW or Honda - is a sequence of of business beha-
united events which amounts to a coherent pattern of business beha- viour.
‘I

viour.

Business Strategy Review Summer 1993

24 JohnKay

If the subject of business strategy focuses on the relationship between

the firm and its environment, there are many key management issues
which it does not address. Strategy is not principally concerned with
employee motivation, or with finance, or with accounting, or with pro-
duction scheduling and inventory control, although these may influence
the firm’s strategy and be influenced by it. In the last two decades, the
pretensions and prestige of the subject of strategy have been such that
strategists have stressed not only the central importance of the issues
with which they deal but also the relevance of strategy to all aspects of
business behaviour. For the same reasons, everyone involved in busi-
“Butstrategy is ness - from the personnel manager to the public relations consultant -
not simply an- has asserted a right to contribute to the strategy process.
other word for im- But strategy is not simply another word for important. There are
portant. There
are many as-
many aspects to good management, and to say that strategy and oper-
pects to good ations management are distinct facets of it is not to disparage either. Yet
management, there is a difference between strategy and these other elements of
and to say that management practice which illuminates the nature of strategy itself and
strategy and may partly explain its supposed primacy. In most industries, there are
operations man-
agement are dis-
many firms which have their finance and accounting right, their human
tinct facets of it is relations right, their information technology adapted to their needs. For
not to disparage one firm to succeed in these areas does not damage others. In imple-
either.” menting finance and accounting, human relations and information tech-
nology, it is right, and normal, to look to the best practice in other firms.
But strategy is not like that. Honda and BMW did not establish their
market positions by methods which built on the best practice of their
”Successful competitors. For both companies, attempts to match their rivals’
strategy is rarely
strategies failed. BMW’s bubble cars were not as well regarded as
copycat strategy.
It is based on Innocenti’s, and its limousines were inferior to those of Mercedes.
doing well what Honda was able to sell powerful motor bikes in the US only after its
rivals cannot do success with quite different products had destroyed its competitors’
or cannot do finances and established its own reputation. Successful strategy is rarely
readily, not what
copycat strategy. It is based on doing well what rivals cannot do or cannot
they can do or
are already do readily, not what they can do, or are already doing.
doing.“

Groupe Bull
Despite its current well publicised problems, IBM has been, for the last
three decades, perhaps the most successful corporation in the world. It
has dominated a large, rapidly growing and profitable market and its
products have changed every aspect of business behaviour. IBM is a high
tech company but its strength is not simply derived from its technology,
where it has often chosen to follow rather than to lead. IBM’s most

Business Strategy Review Summer 1993

 The Structure of Strategy 25

famous advertising slogan - 'No one ever got fired for choosing IBM' -
was not devised or used by the company, but by its customers. It reflects
the company's true distinctive capability - its ability to deliver not just
hardware but solutions to its clients' problems, and its reputation for "The European
having that ability. government most
European politicians and businessmen have long dreamt of creating determined to re-
sist ISM'Sh e g e
a European IBM. The British government promoted ICL, the Germans
mony across the
Nixdorf and Siemens, the Italians supported Olivetti. These companies full range of com-
have succeeded only in subsectors of the computer market. The Euro- puters has been
pean government most determined to resist IBM's hegemony across the the French, and
full range of computers has been the French, and the European company the European
company most
most determined to resist it has been Groupe Bull.
determined to re-
Bull is, curiously, named after a Norwegian whose patented punch sist it has been
card system proved popular with French banks before the second world Groupe Bull."
war. But Bull's greatest success came when its gamma 60 range offered
perhaps the most advanced and innovative machines available as the
computer age dawned in the 1960s. That gave the company a worldwide
name, and marketing capability, but the 90 range which followed failed
to live up to specifications. The company recognised that it lacked the
technical capacity to challenge IBM alone and that the US would be by
far the largest geographic market for computers. It looked for a US
partner, and found a strong one in General Electric. De Gaulle, out-
raged by the dilution of the vision of a French world leader in computing,
first blocked the deal. When it eventually went ahead, the irate Presi-
dent established a state owned, and wholly French, competitor, Cii. Cii
was less successful than Bull and in 1976 the two companies merged.
The firm soon reverted to its original name but the French state now had
a majority stake.
General Electric came to an early conclusion that the computer
market was IBM's, and quit it completely. Bull found a new American
partner in Honeywell. The company enjoyed a captive market in the
French public sector, and did well more generally in Francophone
countries, but elsewhere the gap between IBM and either Honeywell or
Bull continued to widen. Through the 1980s Bull struggled, surviving
only on the continued support of its indulgent principal shareholder.
Eventually Honeywell too gave up the chase, and Bull bought out its
partner.
In 1989, Groupe Bull acquired a new chief executive,Francis Lorentz,
who reasserted the company's primary objective - "Tobecome the major
European supplier of global information systems." (Financial Times, 30
June 1989, p29.) The emphasis had shifted slightly from a French to a
European base, but the central message remained the same. But by now

Business Strategy Review Summer 1993

26 JohnKay

even IBM was faltering. IBM’s distinctive capabilities remained strong,

but markets had changed. A computer had become a commodity, not a
mystery, and there could be one on every manager’s desk. In 1990 Bull
posted large losses, and 1991 was a worse year still. Early in 1992, Bull
announced an alliance with IBM, and Lorentz left the company soon
after.
For thirty years Groupe Bull has been a company driven not by an
assessment of what it is but by a vision of what it would like to be.
“Effective Throughout it has lacked the distinctive capabilities which would enable
strategy starts
it to realise that vision. Bull - and the other attempts at European clones
from what the
company is dis- of IBM - epitomise wish-driven strategy, based on aspiration, not capa-
tinctively good bility. Effective strategy, like that of BMW or Honda, starts from what
at, not from what the company is distinctively good at, not from what it would like to be
it would like to good at, and is adaptive and opportunistic inexploiting what is distinctive
be good at.”
in these capabilities.

Creating Strategy
There is nothing new in saying that strategies should be adaptive and
opportunistic, or that planning should start with an assessment of the
firm’s distinctive capabilities. Yet these observations are often misin-
terpreted. Adaptive strategy is contrasted - quite mistakenly - with
analytical approaches to strategy, while the real contrast is with the
vision, the mission, and the wish-driven strategy, about which there is
nothing analytical at all. To say that we cannot forecast where our
organisations will be in five years time is not to say that we cannot plan
for the future. To say that successful businesses, and successful entre-
preneurs are opportunistic, like Honda, is not to say that firms and
managers should, like the British motor cycle industry, wait to see what
turns up.
When strategists talk of distinctive capabilities they quickly turn to
talk of how to build them. This is evidently important, and most distinc-
tive capabilities have, in some sense or other, been created by the firms
which hold them today. Yet the attempt to establish distinctive capa-
bilities confronts its own version of wish-driven strategy. Building dis-
tinctive capabilities must be a task of exceptional difficulty because, if it
were not, the capability would soon cease to be distinctive. The story of
Komatsu’s conquest of Caterpillar - how a small Japanese company took
on the world’s largest producer of earth-moving equipment, and won -
has become the business equivalent of ‘from log cabin to White House’
(HBS, 1985, 1990). But, like the epic of Abraham Lincoln, it is often

Business Strategy Review Summer 1993

 The Structure of Strategy 27

misinterpreted.’ The lesson of Lincoln’s success is not that anyone can

become President of the United States if they try hard enough, but that
in an open society exceptional talent can thrive however humble its
origins. The lesson of Komatsu is that the internationalisation of mod-
ern business creates commercial opportunities as wide-ranging as the
political opportunities offered by the democratisation of the United
States. Komatsu succeeded because of the quality and competitive price
of its products. Its achievement was the product of its competitive
advantage, not the strength of its will.
So firms should generally look to define and identify distinctive
capabilities rather than create them. Although it is possible to create
distinctive capabilities, success is more often based on exploitation of
those capabilities which the firm already enjoys. These may derive from
its history or from its location, or they may be capabilities which it has
already established in related markets or industries. Strategy begins
with an understanding of what these distinctive capabilities are.

Saatchi & Saatchi

Saatchi & Saatchi was, for a time, the best known advertising agency in
the world. An advertisement devised to promote birth control, which
showed a picture of a pregnant man, created a mixture of controversy
and envy which promoted a small agency controlled by Charles and
Maurice Saatchi to national fame. The agency’s contribution to Mar-
garet Thatcher’s first successful election campaign in 1979 turned that
domestic reputation into an international one.
But international recognition was not enough. The Saatchis deter-
recognition was
mined to create an international business. In 1983, it is reported (by
not enough. The
Fallon, 1988: 203), Maurice Saatchi read a famous article in the Harvard Saatchjs deter-
Business Review on the development of global markets (Levitt, 1983). mined to create
Inspired by the vision it held out, he flew the Atlantic to learn the full an international
details of the new doctrine. These trans-Atlantic flights were to become business.”

1 And, like much written about Lincoln, largely apocryphal.Komatsu entered the US
market with a very aggressive pricing strategy, and imposed massive losses on
Caterpillar, which was unwilling to cede market share, and ready to cut prices to
retain it. Komatsu’s price policy proved difficult for the Japanese company itself to
sustain, and in the end it allowed prices to drift upwards and has settled for a modest
share of the US market (Kotler, 1991, chapter 13).

Business Strategy Review Summer 1993

28 JohnKay

more frequent as the operating companies within Saatchi & Saatchi

came to span not just Britain and the United States but other continents
and other markets.
By the end of the decade, Saatchi & Saatchi was, as the brothers had
intended, the world's first truly international, interdisciplinary, market-
ing and consultancy organisation. It was also in serious financial diffi-
culty. Under pressure from bankers and stockholders, the Saatchis
relinquished executive control and a new management team set to work
dismantling the empire which the brothers' vision had put together,
Saatchi & Saatchi began with a reputation that was unmatched in its
business, and a creative team that was almost equally admired. These
are characteristic assets of the highly successful professional service
firm. The firms it bought were firms which had precisely these assets
themselves. Its largest acquisition, Ted Bates, was itself one of the
largest and most respected advertising agencies in the United States and
had no need of the Saatchi label. It already enjoyed an equivalent
reputation in its own market and there was never any suggestion that it
would trade under the Saatchi name. International customers did not
bring their business to the new merged agency. They took it away,
fearing conflicts of interest as the enlarged concern was often already
handling the accounts of its competitors. Ted Bates was worth less to
Saatchi & Saatchi than to almost any other purchaser. Saatchi already
had those things which made Bates valuable and they were worth less,
"The inherent not more, under Saatchi ownership.
weaknesses of But in the grip of the strategic objective of internationalisation,
the strategy were
concealed by the Saatchi paid alarge premium to gain control of that and other businesses.
growth in the For a time, the inherent weaknesses of the strategy were concealed by
underlying earn- the growth in the underlying earnings of the businesses, and the capacity
ings of the busi- of the Saatchi share price to drift ever upwards on a cushion of hot air.
nesses. " Eventually, earnings faltered and the hot air escaped. The company was
left with a mountain of debt and a collection of businesses that, while
sound in themselves, were not worth the prices that had been paid for
"The company
was left with a them.
mountain of debt Wish-driven strategy failed for Groupe Bull because the goal was
and a collection unattainable. Wish-driven strategy failed for Saatchi 8z Saatchi because
of businesses
that, while sound
the goal, although attainable and attained, was not a sensible one for that
in themselves, particular company to pursue. Wish-driven strategy emphasises the
were not worth importance of the corporate vision, frequently starts with an assertion of
the prices that the mission statement, and creates a company driven by a view of what
had been paid it would like to be. The Saatchi strategy was based on a dream, rather
for them."

Business Strategy Review Summer 1993

 The Structure of Strategy 29

than an analysis of the competitive strengths of the business, and the

company adapted to market realities only when corporate collapse was
staring it in the face.

Sustainability and Appropriability

A capability can only be distinctive if it is derived from a characteristic
"lt is not enough
which other firms lack. Yet it is not enough for that characteristic to be for that charac-
distinctive. It is necessary also for it to be sustainable and appropriable. teristic to be dis-
A distinctive capability is sustainable only if it persists over time. tinctive. It is
Honda's achievement was not only to redefine the US motor cycle necessary also
it to be sus-
market, but to remain leaders in that market. A distinctive capability is fortainable and ap-
appropriable only if it exclusively, or principally, benefits the company propriabfe. "

which holds it. Often the benefits of a distinctive capability are appro-
priated instead by employees, by customers, or by competitors. There
are relatively few types of distinctive capability which meet these condi-
tions of sustainability and appropriability. There are three which recur
in analysis of the performance of successful companies. Innovation is an
obvious source of distinctive capability, but it is less often a sustainable
or appropriable source because successful innovation quickly attracts
imitation. Maintaining an advantage is most easily possible for those few
innovations for which patent production is effective. There are others
where process secrecy or other characteristics make it difficult for other
firms to follow. More often, turning an innovation into a competitive
advantage requires the development of a powerful range of supporting
strategies.
What appears to be competitive advantage derived from innovation
is frequently, in fact, the return to a system of organisation capable of
producing a series of innovations. This is an example of a second
distinctive capability which I call architecture. Architecture is a system
of relationships within the firm, or between the firm and its suppliers
and customers, or both. Generally, the system is a complex one and the
content of the relationships implicit rather than explicit. The structure
relies on continued mutual commitment to monitor and enforce its
terms. A firm with distinctive architecture gains strength from the ability
to transfer firm product and market specific information within the
organisation and to its customers and suppliers. It can also respond
quickly and flexibly to changing circumstances. It has often been
through their greater ability to develop such architecture that Japanese
firms have established competitive advantages over their American
rivals.

Business Strategy Review Summer 1993

30 JohnKay

A third distinctive capability is reputation. Reputation is, in a sense,

a type of architecture but it is so widespread, and so important, that it is
best to treat it as a distinct source of competitive advantage. Easier to
maintain than to create, reputation meets the essential conditions for
sustainability. Indeed, an important element of the strategy of many
successful firms has been the transformation of an initial distinctive
capability based on innovation or architecture, to a more enduring one
derived from reputation.

From Capabilities to Competitive Advantages

A distinctive capability becomes a competitive advantage when it is
' A distinctive ca-
pability becomes
applied in an industry and brought to a market. The market and the
a competitive ad- industry have both product and geographic dimensions. Sometimes the
vantage when it choice of market follows immediately from the nature of the distinctive
is applied in an capability. An innovation will usually suggest its own market. Pilkington
industry and discovered the float glass process, a system by which thin sheets of glass
brought to a rnar-
ket."
were formed on a bed of molten tin, which made the traditional grinding
and polishing of plate glass unnecessary. Little need be said about the
industry and markets where such an innovation is to be applied and it is
other aspects of strategy that are critical. There are few geographical
boundaries to innovation. While most innovating firms will begin in
their home markets, successful innovation is rarely inhibited by national
boundaries. The appropriate product market for an innovation is not
always obvious, and identifying precisely what it is can be crucial. The
demand for video cassette recorders turned out to be based on pre-re-
corded films rather than home movies. That required a playing time of
three hours rather than one. JVC saw that small difference more quickly
than Sony, and that was one key influence on success and failure in that
particular market. The liquid crystal display, a scientific curiosity when
it was introduced, was an innovation waiting decades for an application.
Other firms have distinctive capabilities based on their architecture,
"The same archi-
tecture advant- and the same architecture advantage can often be employed in a wide
age can often be range of industries and markets. For BMW, the choice of industry and
employed in a market segment was by no means obvious, but was ultimately crucial.
wide range of in- For Honda, the choice of market segment did seem obvious. In the wide
dustries and mar-
open spaces of the United States, they anticipated little demand for the
kers. "
small machines which were popular in congested Japan. But this view
was doubly wrong. The market for large bikes which they had chosen
was one in which Honda had no competitive advantage. Success came
only from a very different product positioning. The market segments

Business Strategy Review Summer 1993

 The Structure of Strategy 31

these companies selected, high performance saloons for BMW, light-

weight, low-powered motor cycles for Honda, were both innovative but
well suited to their underlying distinctive capabilities.
Reputations are created in specific markets. A reputation necessarily
“A reputation
relates to a product or a group of products. It is bounded geographically, necessarily re-
too. Many reputations are very local in nature. The good plumber or lates to a product
doctor neither has nor needs a reputation outside a tightly defined area. or a group of pro-
Retailing reputations are mostly national. But an increasing number of ducts.’’
producers of manufactured goods, from Coca-Cola to Sony, have estab-
lished reputations worldwide, and branding has enabled international
reputations to be created and exploited for locally delivered services in
industries as diverse as accountancy and car hire.
A firm can only enjoy a competitive advantage relative to another firm
‘ A firm can only
in the same industry. So BMW may enjoy a competitive advantage over enjoy a competi-
Nissan, but be at a competitive disadvantage to Mercedes. As this tive advantage
example illustrates, a competitive advantage is a feature of a particular relative to an-
market. These three firms compete in several different ‘markets, or other firm in the
same industry.”
market segments, and the pattern of relative competitive advantages and
disadvantages is different in each one. The value of a competitive
advantage will depend on the strength of the firm’s distinctive capability,
the size of the market, and the overall profitability of the industry.
It is easier to sustain a distinctive capability in a narrow market than
a wide one, more profitable to hold it in a wide market than a narrow
one. And the profitability of a firm depends both on the competitive
advantage the firm holds relative to other firms in the industry, and on
the profitability of the industry itself. If there is excess capacity in the
industry - as in automobiles - then even a large competitive advantage
may not yield substantial profits.
But if entry to an industry is difficult, then a firm without any compe-
titive advantage may nevertheless earn very large returns. There is little
reason to think that the large monopolistic utilities which control many
parts of the European energy, transport and communications industries
have strong distinctive capabilities of the kind that characterise BMW,
or Honda, or IBM. Their market dominance has not been built on doing
things that others could not do as well, but on doing things that others
were not permitted to do at all. Yet many of these firms are very
profitable. There can be no greater competitive advantage than the
absence of competitors. Profits come not only from distinctive capa-
bilities but from possession of strategic assets - competitive advantages
which arise from the structure of the market rather than from the specific
attributes of firms within that market.

Business Strategy Review Summer 1993

32 JohnKay

Glaxo and EM1

Corporate strategy is concerned with matching markets to distinctive
capabilities. Business strategy looks at the relationship between the firm
and its competitors, suppliers and customers in the markets which it has
chosen.
In the 1970s, two British firms, Glaxo and EMI, developed important
innovations. Both depended critically on their sales in the US medical
services market (dell'osso, 1990). Glaxo had found an effective anti-
"Glaxo had found
an effective anti-
ulcer drug, Zantac. EMI's scanner was the most important advance in
ulcer drug, Zan- radiology since the discovery of X-rays. Glaxo transformed itself from
tac. EMl's a medium ranking drug company with uncertain future, to Europe's
scanner was the leading pharmaceutical producer. EMT, crippled by losses on its scanner
most important business, ceased to exist as an independent company and is no longer
advance in radio-
logy since the
involved in medical electronics.
discovery of X- EMI's capability was much the more distinctive. The scanner won the
rays." Nobel Prize for Physics for its inventor, Geoffrey Houndsfield. The
market for anti-ulcerants has long been recognised as a potentially
lucrative target - ulcers are common, persistent and rarely fatal. An
effective therapy emerged from the research of a British scientist, Sir
James Black, but it was a US company, SrnithKline, which developed
Tagamet, the first commercial product based on it. Zantac was dis-
covered after Glaxo refocused its research programme following the
publication of Dr Black's results.
For both Glaxo and EMI, the choice of markets was not a difficult
issue. Their markets were suggested by the nature of their innovation.
(Although this was less obvious at an earlier stage of development in the
scanner. EM1 had a defence-based technology seeking an application,
and it was a lateral leap by Houndsfield which took the company into
"The key ques- medical electronics. For Glaxo, however, the innovation followed the
tions for both
market and the market the innovation.)
companies were
issues of busi- The key questions for both companies were issues of business
ness strategy. " strategy. The choice of market identified suppliers, customers and
competitors. Relationships with suppliers were not of special import-
ance to either company, but relationships with customers and cornpeti-
"Relationships
with suppliers tors most certainly were.
were not of spe- EM1 attempted to create its own US distribution network and to price
cial importance at a level designed to recoup development costs. President Carter,
to either com-
pany, but relation-
concerned about spiralling medical bills, imposed a 'certificate of need'
ships with requirement on publicly funded hospitals. This delayed sales while
customers and General Electric developed its own version of the scanner. Although
competitors most EM1 had little experience of any manufacturing in this field, far less
certainly were. "

Business Strategy Review Summer 1993

 The Structure of Strategy 33

overseas, the company established a US manufacturing plant, which ran

into serious output and quality problems. When GE entered the market,
EM1 was rapidly swept away and the rump of the business was sold to its
larger competitor.
Patent protection - which had not proved sufficiently effective either
for SmithKline or EM1 - served Glaxo well, and helped ensure that its
competitive advantage was sustainable. Glaxo began to market its drugs
in the US through Hoffmann-La Roche, whose sales of Librium and
Valium had made the firm by far the most effective European pharma-
ceutical company in the US market. Glaxo entered Japan through a joint
venture with a Japanese partner. In Britain and Italy, where Glaxo had
a strong established market reputation, Glaxo skilfully exploited con-
cern about possible Tagamet side effects, priced Zantac at premia to
Tagamet, which reflected the company’s own variable relative strength
in different markets. By the mid-l980s, Zantac had become the world’s
best selling drug, and over the decade the company earned about f4
billion in profits from its sale. By any standards, Glaxo is an outstand-
ingly successful European company.

Contingency and Resource Based Approaches to

Strategy
The view of strategy developed here derives from the contingency
theory, which is the dominant strand of thought in organisational beha-
viour. Starting from the original work of Burns and Stalker (1966) and
Woodward (1969, contingency theory (Steiner, 1979; Grinyer et al,
1986) emphasises that there is no best form of organisation, and that
organisational success rests on matching the organisation to its environ-
ment. There is a striking congruence here between the sociological
tenets of contingency theory and the financial economist’s efficient
market perspective, which argues that there can be no universal pres-
criptions for success since, if there were, their general adoption would
reduce their value to everyone. These two approaches taken together
lead directly to the conclusion that it is the creation and maintenance of
distinctive capabilities which is at the heart of successful strategy,
The successful match of organisational structure and environment is
“Thesuccessful
not, in itself, a source of competitive advantage; it is a necessary, but not match of organi-
sufficient condition. Banking demands a mechanistic structure - the structure
decentralised processing of millions of daily transactions under common and environment
procedures simply cannot be managed in any other way. But the sources is not, in itself, a
of competitive advantage in banking are to be found elsewhere, in Source OfcomPe-
titive advantage.
reputation and in the architecture of lending relationships. Mechanistic I’

Business Strategy Review Summer 1993

34 JohnKay

structures are, by their very nature, replicable, but certain types of

organic structure - those here identified with architecture - are not.
Contingency theory, given its origins, naturally stresses the organisa-
tional contribution to distinctive capabilities.
The contribution of economics to our understanding of distinctive
capabilities is both to broaden and to narrow the range. It broadens it
in importing factors which are not behaviourial but which nonetheless
contribute to competitive advantage, emphasising particularly the role
of strategic assets. It narrows it by focusing attention on characteristics
of the organisation which are both appropriable and irreproducible.
This latter emphasis is missing in the very wide range of distinctive
competencies identified by Snow and Hrebiniak (1980).
The necessary irreproducibility of capabilities which yield sustainable
competitive advantage has been developed by a number of authors.
Teece (1986) draws particular attention to the appropriability problem
associated with innovation. Prahalad and Hamel (1990) are concerned
with similar issues in the context of organisational knowledge, and Oster
(1990) is particularly effective in stressing the efficient market perspec-
tive in this context. Lippman and Rumelt (1982) review the issue more
generally and the concept of architecture owes much to their 'uncertain
imitability' (usefully developed by Reed and De Filippi (1990) and
Barney (1991)) - copycat strategies fail because the potential copier
cannot easily identify what it is that it is necessary to copy. Grant (1991)
usefully draws a number of these themes together.
An emphasis on the creation and maximisation of rents as the engine
'Hn emphasis on
the creation and
of commercial activity is, of course, hardly a new idea. Elements of it
maximisation of can be found in Ricardo (1819), to whom the concepts of rents and
rents as the en- quasi-rents are due, but by far the most forceful exposition of this
gine of commer- perspective remains that of Schumpeter (1934). Yet this work has not
cial activity is, of been in the mainstream of economic thought. Industrial economics has
course, hardly a
new idea."
followed broadly the traditions of Alfred Marshall, whose primary unit
of analysis was 'the representative firm', and in subsequent models of
competition firms differed not at all from each other or did so in
essentially trivialways (see Kay, 1991,for an elaboration of these points).
It is, indeed, this perspective which justified Ansoff's rejection of micro-
economics as a basis for strategy - 'microeconomic theory provides for
no differentiation of behaviour among firms ... as a result, the traditional
microeconomic theory is neither rich nor extensive enough for our
purpose' (Ansoff, 1969). Although these criticisms are much less valid
as applied to microeconomic theory today, the contribution of econ-
omics to strategy has remained slight.

Business Strategy Review Summer 1993

 The Structure of Strategy 35

Looking to the Future

Yet it is clear that the subject of strategy has suffered from this neglect ,,The of
of obvious roots in sociology and in economics. Too much of what is strategy has suf-
offered as strategy consists of lists or platitudes. The value of these is fered from this
not negligible. Lists are aids to structured thought. Platitudes are often neglectofob-
vious roots in so-
platitudes because they are necessary reassertions of important truths.
ciology and in
But the claims which can be made for knowledge of this kind are modest economics~t,
indeed.
For centuries, the subject of medicine was mostly nonsense. Doctors
applied fashionable nostrums, sometimes bleeding their patients, some-
times starving them. Generally these remedies were useless, sometimes
they were fortuitously beneficial, at other times unintendedly harmful.
States of health were defined by reference to ascientific categorisation,
such as the humours or the elements. The prestige of a doctor rested
more on the status of his patients and the confidence of his assertions
than on the evidence of his cures.
The parallels are obvious, if not exact, and the reasons for the parallels
are obvious too. Both medicine and management deal with urgent and
pressing problems. The demand for a cure is so pressing that critical
faculties are suspended. The quack who promises relief often receives
a warmer welcome than the practitioner who recognises the limitations
of his own knowledge, and since it is difficult to measure the effective-
ness of treatment, this impression may persist even after it is over.
But in the last 150 years, the application of scientific method to
medical subjects, and the development and adoption of knowledge
gained in physics, chemistry and biology, has transformed their effective-
ness. Medicine remains a practical subject. The experience and judge-
ment of a good doctor is as important as the extent of his knowledge and
the quality of his training. Untrained individuals continue to express
opinions on medical matters, not all of which are wrong. But few of US "The subject of
would now wish to put ourselves in the hands of doctors who had no such management has
knowledge or training, or who professed to despise it. far to go before it
can claim the
The subject of management has far to go before it can claim the scientificstarus
scientific status achieved by modern medicine. The attempt to develop achieved by mod-
a coherent framework for the understanding of business behaviour is a ern medicine."
necessary first step towards that goal.

John Kay is Chairman of London Economics, a specialist economic

consulting group, and is also Professor of Economics at the London
Business School. He was the Director of the Centre for Business Strategy
from 1986-91, and the founding editor of Business Strategy Review. This

Business Strategy Review Summer 1993

36 JohnKay

paper is based on material from his book, 'Foundations of Corporate

Success: published on 25 March by Oxford University Press, which encap-
sulates much of his research at the Centre.

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