A Proposed Pentagon Model of Strategic Formulation

Abstract

This paper suggests the need for managers to take, as a reference model for their strategic
choices, a congruent decisional matrix composed of environmental and contextual factors,
as much as variables of an eminently internal nature (resources). A pentagon-shaped model
is proposed herein, in which the five key strategic choices are identified for leaders of small
and medium-sized enterprises - the product portfolio, the customer portfolio, the
geographic scope, the position in the industry value chain, and the distribution network.
 The Strategic Pentagon

(1) The product portfolio

Whatever the analytical sieve and associated tools, the choice of competitive arena(s)
emerges as the first level of the strategic decision-making process, commonly referred to as
corporate strategy. Once set, a second level of choices comes into play: those relating to
industrial placement within the selected industry(ies), something that Porter refers to as the
selection of the strategic group in which the company intends to compete. In an industry,
each strategic group consists of companies that are similar in objectives and strategic
dimensions and, therefore, compete more directly with each other. By choosing a particular
industrial positioning, the company is setting its value proposition and delimiting its
competitive territory. If its strategic approach is global, intending to cover every market
segment, it will have to equip itself with a manifold arsenal through separate deals for each
macro-segment. If, on the contrary, its positioning is narrow, the second-level range of
choices is reduced to the general configuration of the value supply due to the different
characteristics of the strategic groups in action. For most installed SMEs, this second level
is where the strategic decision-making process begins.

The third decision-making level is associated with the concept of business strategy. Once
the product has been broadly defined (industry) along with the generic features of the value
offer (the strategic group), the company (or business unit) has to move on to the concept
and design of the range of products and services with which it intends to address the
market. This is a particularly critical choice, insofar as it concerns the first of the three
ingredients of the competitive formula - value offer. Entrepreneurial success comes from its
degree of adaptation to the expectations and perceptions of target segments, together with
operational efficiency and marketing effectiveness.

The time for conceiving and designing the product portfolio should involve inputs of a
competitive, economic and operational nature. In large companies, this stage of decision-
making usually involves diverse internal valences such as business intelligence, marketing,
sales, or production. In SMEs, this is often centralized in a small number of decision
makers - sometimes in just one: the entrepreneur - and, therefore, the absorption of inputs
must be based on experience, through careful and continued observation of productive and
commercial fronts.

(2) The customer portfolio

The selection of customers to be targeted is closely related to decisions regarding the

makeup of the offer. The industrial positioning of the company - defined above as the
second level choice of the product - implicitly entails a pre-selection of macro-segments to
whom the offer is addressed and an analytical reading of its core features.

To a large extent, the industry's features influence the type, frequency and depth of the
analysis of demand. Firstly, by the nature of industrial or consumer output. Industrial goods
are geared to organizations, in B2B or B2A transactions; consumer goods are geared to
individuals in B2C transactions. In general, the criteria for segmentation of industrial
markets are more stable and confined to a limited number of variables, although they may
come upon added difficulties with regard to the decision-making processes of buyers. In
consumer markets, the complexity and instability of consumer behaviour are a permanent
challenge to the ability to grasp and systematize expectations, habits and perceptions.

The complexity and capillarity of the current economic system and its institutions introduce
additional difficulties in segmentation, analysis and selection of target segments. In
industrial markets, the trend towards outsourcing of productive operations - along with the
concentration of core activities - and towards geographical diversification of sources of
supply add new depth requirements to the analysis of customers' needs, behaviours and
decision-making processes. In consumer markets, marked by two seemingly contradictory
trends - fragmentation of customs and homogenization of tastes - traditional socio-
economic segmentation is losing explanatory power on the evolution of consumers'
motivations and behaviours. Along with classical criteria, we have countless batteries of
psychological, perceptual, aspirational, behavioural (lifestyle) and group variables, in an
analytical sophistication often associated with behaviour patterns of a psychographic type -
the "targets" of the marketing strategy.

No matter how strict and thought-out the exercise of selecting target segments, it will be of
little use if the choices do not turn out to be congruent with the remaining four sides of the
pentagon, in particular with the company's product portfolio. The final challenge consists of
taking advantage of internal resources and skills towards meeting the needs of the segments
that you want to address. This is the complete domain of business strategy.

(3) The geographic scope

This is one of the classic elements of any strategic setting. From local to planetary, there is
a whole range of supply and combat areas available to businesses, from small proximity
businesses to large transnational operations.

Normally, the geographical scope of action directly relates to the business dimension. In
most countries, the lion's share in the number of economic units is that of formal micro-
enterprises, of which a considerable majority is active in trade and services. In these, the
geographic scope of operations is usually limited by the business' very nature of
convenience or proximity. Exceeding the limited scope for which they were created will
depend on multiple factors, which may include the quality and reputation of the value offer,
the scalability of the operation, the available economic resources and entrepreneurial
qualities of leadership and management. The absence of one or more of these ingredients
does not necessarily condemn the company to stagnation or to sub-par results, but severely
limits their expanding horizons.

In the universe of SMEs, the outlook does not seem substantially different. Despite the
predominance of commercial units and local services not being as sharp, its geographical
sphere of action rarely exceeds the national, if not regional, scope, which often puts them at
the mercy of foreign competitive assaults. For SMEs, the territorial challenge has become
increasingly as an exercise of survival. Just as for micro-enterprises, success in expanding
the geographical scope will depend on the value offer, resources, operational scalability and
management.

Thus, any decision to extend the geographical sphere of action must be preceded by a
careful balancing of potential gains and increased complexity of operations. Such
precautions should be substantially strengthened when the time comes for
internationalization. Regardless of the degree of knowledge of foreign markets (regarding
factors or consumption) and attractiveness of their business environments, the choice for an
international strategy for the company necessarily carries higher risk levels, taking it to new
levels of demand in management.

Despite the globalizing momentum of the global economy and growing imperatives of
international competitiveness for industries producing tradable goods and services,
internationalization risks remain high for SMEs. As they are traditionally weak in dynamic
competitiveness factors - such as product or brand engineering - the implementation of
activities in the global sphere is repeatedly achieved at the expense of sacrificing its own
identity, referring them to situations of contractual dependency, in some cases close to
captivity.

(4) The position in the industry value chain

The combined phenomena of globalization and fragmentation of industrial sectors have

caused profound changes in the economic fabrics and competitive positioning of
companies. The mobility of technologies and processes, along with the opening of markets
for factors, introduced increasingly demanding parameters in terms of competitiveness and
operational efficiency, which companies seek to meet through demand for ingenious
combinations of internal and external resources. The intra-industrial networks are the
natural development of this new global context, emerging at once as a consequence of the
disintegration of value chains and seeking win-win relationships between complementary
companies, whose more or less specialized distinctive behaviours can generate above-
average income in the industrial sector where they strive.

In the absence of corporate constraints or heightened customer-supplier dependencies,

businesses have many options regarding the structure of their value chains, where two key
dimensions prevail: the extent and depth. The extent is related to the degree of overlapping
of business value chain with that of the industrial sector. In general, large global companies
have a wider presence in the sector. However, it is certainly not the norm in the universe of
SMEs, where small scale tends to specialize the nature of the business around a limited
range of activities in the industrial sector.

Just as the choices regarding the range of products, customer base and geographic scope,
any movement towards greater positional latitude implies that resources are consistent with
the increased complexity in management. The weights are economic and competitive:
extending the industrial scope presumes the existence of advantageous factors in upstream
or downstream integration, of new primary activities and prospects for achieving a more
aggressive and comprehensive competitive positioning, generating greater economic
results. When moving in the opposite direction (i.e., shrinkage of industrial scope), this
should also obey a strategic choice, driven by demand for levels of competitive
effectiveness and increased production efficiency, even if at the expense of a stagnation or
decline in turnover.

The second dimension - the depth of the value chain - is expressed by the level of
outsourcing of primary activities and by the network of interconnections among both
internal and external players that contribute to the company's value offer. Business models
based solely on their own resources from the beginning to the end of the process of value
creation are becoming less frequent, particularly in the universe of SMEs, The fragmenting
of markets and mobility of factors led to strong movements of vertical disintegration and
production-related specialization.
At the present time, any company is required to find the best combination between
controlling the value chain, specialization of resources and outsourcing of activities,
insofar as perhaps no economic organization has the resources and skills necessary to
achieve a position of competitive superiority in every primary and secondary activity.
Companies, therefore, seek to identify the activities where the external acquisition of
components, goods or services is likely to add value to their offer without sacrificing their
central role of commanding and controlling the production chain. Where outsourcing is
successful, it is possible to gain strategic and operational flexibility, lower industrial risk,
and reduce tangible and intangible investment needs.

(5) The distribution network

Not surprisingly, some of the main difficulties of SMEs pertain to the difficulty in
accessing distribution networks, both national and international, particularly in consumer
markets. Accordingly, knowledge of the distribution grid, increasingly concentrated around
major brands with strong bargaining power, has proved to be not only a key factor for good
business performance, but also a conditioning factor of the competitive formula itself, in
particular of its value offer.

In markets for industrial goods, with a greater or lesser degree of specialization, the choices
concerning the distribution network are usually more limited. In some cases, they are
mainly connected to good knowledge of demand and to the strength of commercial
relations, based on relations involving technical, institutional and personal trust. The more
specialized the offer, the lower the number of potential customers will tend to be, thus
introducing ingredients comprising greater intensity and smaller diversity of choices. Even
so, networking needs do not diminish, insofar as the performance of this type of business is
often linked to the ability to influence and make inroads in closed and increasingly
organized networks of suppliers, either spontaneously or in a guided manner, around a core
of first level command - when directed by the end integrator - or lesser levels - when
subject to corporate bodies and rules governed by a sub-integrator of related activities and
products in large, stratified industrial sectors.

In consumer goods markets, the choices regarding the distribution network are more
complex, given the variety of options available. Again, excluding proximity businesses,
subject to simple and usually autonomous commercial models, SMEs are faced with the
difficulties of integration between the small production scale and the power of distribution
networks. Given multiple choices, from the broad-spectrum channels, at one extreme, to
tactical exclusivity, at the other, companies seek to come up with the best combination of
features between the offer value, operational flexibility and the ability to position
themselves in networks (whose complexity increases with the scope of the geographic
sphere of action) or simple distribution channels. Thus the product-channel relation seems
to become increasingly biunivocal.

Along with the world of physical distribution and its interconnections, we have electronic
and mixed networks. Today, the Internet offers an ocean of opportunities for SMEs, both in
terms of fostering and disseminating offers, as well as in their own trading. In business of
an immaterial nature, generally linked to the provision of information or leisure content, the
entire value chain can reside in electronic media, from production to distribution, thus
requiring specific skills in managing digital platforms. In those of a material nature or in
services, the Internet can serve as an exclusive or concurrent primary or secondary
marketing network, but always followed by the physical delivery of goods or the provision
of services. In both cases, companies have to make choices between physical and digital
distribution platforms and, increasingly, the development of internal skills that ensure
effective interconnection between activities - either internal or related to external
networking - associated with the physical and electronic aspects of the value chain.

Closing remarks

The strategic pentagon suggested in this paper is a proposal for systematizing the most
important aspects in the strategic decision-making process. Its five sides - product portfolio,
customer portfolio, geographic scope, position in the industrial value chain, and the
distribution network - seek to incorporate internal and external variables, determining
factors in seeking above-average performances, both from the standpoint of developing
existing operations, and from that of making inroads into new businesses. Given the
composite nature of each one and the inter-penetration of its constituent parts, there is
certainly a strong correlation between them, thus mutually conditioning them. The
linearization of strategic choices surrounding these five aspects will, however, enable
SMEs to discuss in a structured manner their chances of success in competitive arenas
where they are battling or where they seek to battle.

Lus Filipe Nazar

Associate Professor
Instituto Superior de Economia e Gesto (ISEG)
Universidade Tcnica de Lisboa