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Strategy and business economics.

Strategy and Business Economics

WHAT IS STRATEGY? Many different theories and approaches to strategy formulation and implementation are presented in the literature. Some writers distinguish between strategy as a concept and strategy as a process. Others emphasize that strategy is a way of thinking. However defined, strategy is concerned with the most important decisions made in an enterprise. The central thrust of these decisions is the future of the organization. While the horizon is the long view, strategy to be implemented properly also must take account of mid-term and short-run decisions and actions.

Strategy is formulated in many different ways. The strategic planning process can be performed on the basis of some set of formal procedures and/or informally in the minds of managers. Strategy is not static. Individual strategies, plans, policies, or procedures are utilized, but they are not the whole story. Strategic planning is behavior and a way of thinking, requiring diverse inputs. In these continuing interactive processes, business economics has a powerful role to play.

Because strategic planning is concerned with the future of the organization, it follows that ultimate responsibility resides in the top executive (group). While many others perform important roles and have important responsibilities for strategic thinking and in the strategic planning processes and behavior, the chief executive (group) must take ultimate responsibility for its success or failure. The chief executive officer (CEO or group) is responsible for the strategic planning process for the firm as a whole; the top manager of a division must be responsible for strategic planning for that division and for conforming it to strategic planning for the organization as a whole.

While different approaches to strategic planning may be found, they will include the steps set forth in Table 1, which indicates the critical activities involved in strategic planning processes. These procedures are described at length in the vast literature on strategy. Whether these represent formal or informal procedures, they are elements to be covered. In each of the strategic planning business economists have something of value to offer in the decision-making processes.

Table : Table 1

Essential Elements in Strategic Planning Processes

1. Assessment of changes in the environments. 2. Evaluation of company capabilities and limitations. 3. Assessment of expectations of stakeholders. 4. Analysis of company, competitors, industry, domestic

economy, and international economies. 5. Formulation of the missions, goals, and policies for the

master strategy. 6. Development of sensitivity to critical external

environmental changes. 7. Formulation of internal organization performance

measurements. 8. Formulation of long-range strategy programs. 9. Formulation of mid-range programs and short-run plans. 10. Organization, funding and other methods to implement

all of the above. 11. Information flow and feedback system for continued

repetition of above and for adjustments and changes at

each stage. 12. Review and evaluation of above processes.

DIVERSITY IN STRATEGIC

PLANNING PROCESSES

Some elements required for all strategic planning activity have been identified. In other aspects of strategic planning, wide diversity is encountered. First, alternative models will be outlined, then illustrative approaches of more relevance to business economics will be developed.

Monitoring Environments

A key to all approaches to strategic planning is continuous monitoring of the external environments. The environments should encompass both domestic and international dimensions and include analysis of economic, technological, political, social, and legal factors. Different organizations will give different emphasis and weights to each of the categories.

Stakeholders

The strategic planning processes must take into account the diverse stakeholders of organizations. Stakeholders are the individuals and groups that have an interest in the organization and its actions. They include: customers, stockholders, creditors, employees, governments, communities, media, political groups, educational institutions, financial community, and international entities.

Writers disagree on the appropriateness of the stake of each of the groups listed. One view is that the firm need only maximize profit or shareholder stock values to maximize the long-run interests of every group. Another is that by balancing properly the interests of major stakeholders, the long-range interests of all will be maximized.

Organization Cultures

How the organization carries out the strategic thinking and planning processes will also vary with its cultures. Illustrative organization cultures are:

1. Strong top leadership vs. teams approach.

2. Management by formal paperwork vs. management

by wandering around.

3. Individual decisions vs. group consensus decisions.

4. Rapid evaluation based on performance vs. long-term

relationship based on loyalty.

5. Rapid feedback for change vs. formal bureaucratic

rules and procedures.

6. Narrow career paths vs. movement through many

areas.

7. Risk-taking encouraged vs. "one mistake and

you're out."

8. Big-stakes (bet-your-company) decisions vs. low-risk

activities.

9. Narrow responsibility assignment vs. "everyone

in this company is a salesman (or cost controller,

or product quality improver, etc.)."

10. Learn from the customer vs. we know what is best

for the customer.

Some of these examples may appear to be caricatures, but they are encountered in practice. In addition, they convey the wide variations in corporate cultures and how the strategic thinking and planning processes may be affected.

Alternative Strategy Methodologies

Alternative approaches to strategy formulation are next considered. The following are examples:

1. SWOT OR WOTS UP - inventory and analysis

of organizational strengths, weaknesses; environmental

opportunities and threats.

2. Environmental Scanning - continuous analysis of

all relevant environments.

3. Gap Analysis - assessment of goals vs. forecasts

or projections.

4. Competitive Analysis - assess customers, suppliers,

new entrants, products and product substitutability.

5. Top-Down or/and Bottom-Up - company forecasts

vs. aggregation of segments.

6. Computer Models - opportunity for detail and

complexity.

7. Institution - insights of brilliant managers.

8. Synergy - look for complementarities.

9. Enterpreneurship - creative leadership.

10. Delphi Technique - iterated opinion reactions.

11. Logical Incrementalism - well-supported moves

from current bases.

12. Muddling Through - incremental changes selected

from a small number of policy alternatives.

13. Discontinuities - crafting strategy from recognition

of trend shifts.

14. Brainstorming - free from repeated exchange of

ideas.

15. Game Theory - logical assessments of competitor

actions and reactions.

16. Game Playing - assign roles and simulate alternative

scenarios.

17. Comparative histories - learn from the experiences

of others.

18. Adaptive Processes - periodic reassessment of

environmental opportunities and organization capability

adjustments required.

The nature of each approach has only been sketched. But the list conveys the profusion of methodologies encountered in strategic planning. Also, even the brief descriptions suggest that the subject matter of each methodology involves business economics.

Alternative Analytical Frameworks

Of greatest relevance to economists is the choice of alternative analytical frameworks for strategy formulation. Their nature is indicated by the following:

1. Product Life Cycles - introduction, growth, maturity,

decline stages with changing opportunities

and threats.

2. Learning Curve - costs decline with cumulative

volume experience resulting in first mover competitive

advantages.

3. Competitive Analysis - industry structure, rivals'

reactions, supplier and customer relations, product

positioning.

4. Cost Leadership - low cost advantages.

5. Product Differentiation - develop product configurations

that achieve customer preference.

6. Value Chain Analysis - controlled cost outlays to

add product characteristics valued by customers.

7. Niche Opportunities - specialize to needs or interests

of customer groups.

8. Product Breadth - carry over of organizational

capabilities.

9. Correlations with Profitability - statistical studies

of factors associated with high profitability measures.

10. Market Share - high market share associated

with competitive superiority.

11. Product Quality - customer allegiance and price

differentials for higher quality.

12. Technological Leadership - keep at frontiers of

knowledge.

13. Relatedness Matrix - unfamiliar markets and

products involve greatest risk.

14. Focus Matrix - narrow vs. broad product families.

15. Growth/Share Matrix - aim for high market share

in high growth markets.

16. Attractiveness Matrix - aim to be strong in attractive

industries.

17. Global Matrix - aim for competitive strength in

attractive countries.

Some of these are self-explanatory or tautological. Low cost leadership, high product quality, or technological leadership are obviously great to have; the challenge is how to achieve them. Moreover, these different analytical frameworks are not mutually exclusive. Indeed some successful consulting practices have been developed by emphasizing selected groups of these analytical frameworks. Three approaches will be described.

APPROACHES TO FORMULATING STRATEGY

Many different schools of thought in the strategy field can be observed. Each represents some combination of the methodologies and/or analytical frameworks in the preceding lists. Three approaches are discussed more fully to illustrate issues relevant for business economists. They are: (1) The Boston Consulting Group; (2) The Porter Approach; and (3) Adaptive Processes.

The Boston Consulting Group

The Boston Consulting Group (BCG) historically emphasized three concepts; the experience curve, the product life cycle, and portfolio balance [Henderson, 1984; Boston Consulting Group, 1985].

The experience curve represents a volume-cost relationship. It is argued that, as the cumulative historical volume of output increases, unit costs will fall at a geometric rate. This relationship is said to result from specialization, standardization, learning, and scale effects. The firm with the largest cumulative output will have lower costs, suggesting a strategy of early and price policies to develop volume.

The product life cycle holds that every product or line of business proceeds through four phases: development, growth, maturity, and decline. During the first two stages, sales growth is rapid and entry is easy. As individual firms gain experience and as growth slows in the last two stages, entry becomes difficult because of the cost advantages of incumbents. In the decline phase of the product line (as other product substitutes emerge) sales and prices decline; firms that have not achieved a favorable position on the experience curve become unprofitable and either merge or exit from the industry.

Related to the product life cycle is the concept of portfolio balance. In the early stages of the product life cycle, rapid growth may require substantial investments. Such business segments are likely to require more investment funds than are generated by current profitability levels. As the requirements for growth diminish, profits may generate more funds than required for current investment requirements. Portfolio balance seeks to combine attractive investment segments (stars) with cash generating segments (cash cows), eliminating segments with unattractive prospects (dogs.). Overall, total corporate cash inflows will roughly balance total corporate investments.

While the volume-cost relationships implied by the experience curve have been documented for some industries, particularly commodity-type products, their general applicability has not been substantiated. Microecenomics would suggest that the emphasis on cost advantage neglects opportunities provided by product quality, variety and innovation. The emphasis on growth and/or portfolio balance may be inconsistent with maximization of shareholder value. The practical application of the BCG strategy to develop a dominant market share in an emerging industry may be difficult to implement; if many firms try to do the same thing their efforts may become self-cancelling. Some argue also that substantial aspects of experience are a part of knowledge that rapidly diffuses across firms and industries. [Thomas, 1986]

The Porter Approach

Michael Porter has elaborated his views in a number of writings [Cf. Porter, 1980, 1985, 1987]. His approach can be summarized into three parts: (1) Select an attractive industry; (2) develop competitive advantage through cost leadership and product differentiation; and (3) develop attractive value chains.

Porter defines an attractive industry or strategic group as one in which

"entry barriers are high, suppliers and buyers have

only modest bargaining power, substitute products

or services are few, and the rivalry among competitors

is stable. An unattractive industry like steel

will have structural flaws, including a plethora of

substitute materials, powerful and price-sensitive

buyers, and excessive rivalry caused by high fixed

costs and a large group of competitors, many of

whom are state supported." [Porter, 1987, p. 46]

The difficulty of generalizing about industries is demonstrated by Porter's example. During the past decade minimills have flourished and by 1988 some major steel firms had returned to profitability. In addition, there appears to be an inconsistency in that high fixed costs are considered to be an entry barrier in Porter's theory.

Second, Porter formulates a matrix for developing generic strategies.

Competitive advantage may be based on cost leadership or on product differentiation. Cost advantage is achieved by consideration of a wide range of checklist factors including BCG's learning curve theory. The focus of cost advantage or of product differentiation can be on narrow market segments (or niches) (for autos, the luxury car market - Cadillac, Continental, BMW, Mercedes, etc.) or broader market groups (compact and standard cars) or across-the-board (GM).

Porter's third key concept is "the value chain." A matrix relates the support activities of infrastructure, human resource management, technology development, and procurement to the primary activities of inbound logistics, operations, outbound logistics, marketing-sales, and service. The aim is to minimize outlays in adding characteristics valued by customers.

Porter's prescriptions can be interpreted as finding an industry or industry sector in which a small number of firms can "cooperate" (collude) behind high entry barriers. While many insights are found in the related checklists developed, the basic philosophic orientation is flawed. It is similar in spirit to the structural theory of industrial organization economics that evidence in recent years has controverted [CF. Weston, 1978, 1982, and references cited]. If barriers to entry are high, the costs of entry or acquisition will permit only a normal rate of return. Moreover, business economists recognize that the dimensions of products and prices are so numerous and subject to such rapid change that collusive efforts could not achieve sustained effectiveness. Furthermore, the benefits of competitive superiority far outweigh the dubious gains from attempts at collusion.

Adaptive Processes

Other writers have been more electric than the two approaches just described. These writers view strategy more as an adaptive process or way of thinking. [See, for example, Ansoff, 1965; Steiner, 1979; Steiner, Miner, and Gray, 1986; Bogue and Buffa, 1986; Quinn, Mintzberg and James, 1988] Some writers also emphasize the uniqueness of each firm. "In essence, the concept is that a firm's competitive position is defined by a bundle of unique resources and relationships and that the task of general management is to adjust and renew these resources and relationships as time, competition, and change erode their value." [Rumelt, 1984, p. 557]

More generally, the adaptive processes orientation involves matching resources to investment opportunities under environmental uncertainty compounded with uncertain competitors' actions and reactions. Business economics has much to contribute in dealing with these kinds of "ill-structured problems." The methodology for dealing with them requires an iterative solution process to which business economics can make significant inputs. The business economist has a key role to play in the studies involved in the repeated "going around the loop" of the strategic planning processes outlined in Table 1.

In going through the iterated checklist procedures, the difficult questions encountered are ones that involve the subject matter of managerial economics. For example, is the firm maximizing its potential in relation to its feasible environment? Is there a gap between the firm's goals and prospects based on its present capabilities? Shall the firm attempt to alter its environment or capabilities or both? Shall the firm change its missions? What will be the cost of each alternative? What are the risks and unknowns? What are the rewards of success and penalties of failure?

The methodology involves not closed-form mathematical solutions but processes. It involves ways of thinking, which involves assessment of competitor's actions and reactions in relation to the changing environments.

EVALUATION OF THE ALTERNATIVE

APPROACHES

While some approaches emphasize generalizations, all make heavy use of checklists that have evolved into expert systems. Writers who have emphasized strategy implementation recently have shifted from a list of precepts to an emphasis on flexibility.

Checklists and Iterations

The adaptive processes methodologies emphasize the use of checklists to stimulate insights, but the BCG and Porter approaches to strategy formulation also rely heavily on similar techniques. For example, in his earlier book on Competitive Strategy [1980], Michael Porter utilized 134 checklists and checklist-like diagrams - one about every three pages. In his later Competitive Advantage [1985], the number had expanded to 187 checklists and checklist-like diagrams - about one every two-and-a-half pages. Stryker [1986] (adaptive approach) has 174 checklists in 269 pages - one checklist per 1.5 pages. Thus the process of strategic planning includes the art of making checklists, going around the loop iteratively, with the expectation that the thinking stimulated will lead to useful insights and sound strategies, policies, and decisions.

The BCG and Porter approaches emphasize prescriptions. But in their actual implementation, they employ checklists not limited to the generalizations each emphasizes. In practice all approaches to strategy become relatively eclectic.

With the greater use of computers in strategic planning, the different approaches appear to have more and more elements in common. Particularly in recent years, expert systems and other decision-support systems have been developed. These represent a disciplined approach to strategic planning, in which rules are used to guide implementation of the iterated checklist approach, making use of ideas from a wide range of philosophic perspectives [Chung and Davidson, 1987].

Some Recent Developments

Publications by writers who have popularized strategy implementation exhibit a recent change in emphasis. In their earlier book entitled In Search of Excellence, Peters and Waterman [1982] asserted that the precepts for success could be reduced to a short checklist: (1) bias for action; (2) close to the customer; (3) autonomy and entrepreneurship; (4) productivity improvement; (5) hands-on, value driven; (6) stick-to-core businesses; (7) simple form, lean staff; and (8) loose-tight properties.

Peters and Waterman admonished their readers to "learn how the best-run American companies use these eight basic principles to stay on top of the heap!" [Peters and Waterman, 1982] Although In Search of Excellence was a commercial success, it also received some criticisms. [Carroll, 1983; Johnson, Natarajan, and Rappaport, 1985; Ramanujam and Venkatraman, 1988] Of particular interest to business economists was the analysis in the cover story of the November 5, 1984, issue of Business Week entitled, "Who's Excellent Now? Some of the Best-Seller's Picks Haven't Been Doing So Well Lately." Business Week studied the forty-three "excellent" companies and concluded that many had encountered difficulties. The article observed:

"Of the 14 excellent companies that had stumbled,

12 were inept in adapting to a fundamental change

in their markets. Their experiences show that strict

adherence to the eight commandments - which

do not emphasize reacting to broad economic and

business trends - may actually hurt a company."

[Business Week, 1984, p. 74]

Peters and Waterman appear to acknowledge the deficiencies in their earlier prescriptive approach by shifting their emphasis in later publications. In The Renewal Factor, Waterman emphasizes flexibility; he quotes with approval the executive who stated that he wanted his managers to be "Fred Astaires - intellectually quick, nimble, and ready to act." [1987, p. 6] Similarly the coauthor of the earlier book on Excellence, in his 1987 publication begins, "There are no excellent companies. The old saw `If it ain't broke, don't fix it' needs revision. I propose: `If it ain't broke, you just haven't looked hard enough.' Fix it anyway." [Peters, 1987, p. 1] Similarly, two executives associated with the Boston Consulting Group have proposed that to manage for increased competitiveness companies need to "make decisions like a fighter pilot" [Hout and Blaxill, 1987, p. 3]

Implications for Business Economists

Flexibility and rapid adjustments are more the stuff of tactics, not strategy! This statement underscores the potential contributions to the strategic planning processes by business economists. Business economics is forward looking, projecting market and supply conditions and patterns. Economic analysis can help identify prospective changes in such areas as demand, product differentiation, market growth segments, and behavior of rivals. Analysis of supply conditions can help identify areas of potential cost changes and thus targets for cost control. Economic analysis can delineate critical monitoring variables to indicate when changes in economic directions are likely to occur. Given this information, tradeoff analysis (the bread and butter of economic marginal analysis) can identify and analyze alternative paths of action and their consequences. In short, business economics aids in dealing with uncertainty and in anticipating change, rather than reacting to events after they have occurred.

Business economists seek an understanding of environmental developments to identify the trends and discontinuities important to strategy formulation and implementation, as well as for providing a framework within which flexibility and adjustments can be achieved efficiently. This proposition will be developed in the following section on the potential role of business economists in the strategic planning processes.

THE WORK OF THE BUSINESS ECONOMIST

The work of business economists and their writings contain important inputs for strategic planning, as indicated in Table 2. Even a bare-bones listing of topics reflecting "the business economist at work" suggests the richness of potential contributions by business economists to the strategic planning process. Grouping is by the traditional dichotomy of macro and micro, but considerable interactions are involved.

Table : Table 2 Inputs for Strategic Planning
Macroeconomic Subjects Microeconomic Subjects
International economics International competition
Individual foreign countries Industry trends
The domestic economy Industry changes
Industry developments Competitor actions and reactions
Exchange rates and implications Demographic changes and their
Interest rates and funds implications
 availability Consumer behavior patterns
Equity values and costs Competing products
Prices, trends and patterns Demand elasticity analysis
Wage levels Supply elasticity analysis
Monetary policy Changes in technology and their
Tax policy implications
Spending policies and patterns Product and segment profitability
 analysis
 Human resources analysis
 Production methods and trends
 Wage contracts and cost
 implications
 Sales forecasting and marketing
 Public affairs


These subjects represent the business economist at work and suggest useful inputs to the strategic planning process. Indeed one writer has proposed that business economists take over this responsibility in the firm. [Gilad, 1986]

"Business economists should take over the strategic

planning function in the corporation and in so doing

employ their skills more profitably in the service

of the needs of their companies. The timing is right.

The traditional functions of the business economist

are eroding away, providing an incentive for new

ventures. The promised land, strategic planning,

on the other hand, is very much up for grabs for

anyone who can bring discipline and systematic

thinking to bear on it." [pp. 31-32]

This approach is wrong. First, strategic planning is the ultimate responsibility of top management. Second, many disciplines and functions have contributions to make. Third, the potential contributions of the traditional areas of business economics have expanded, not narrowed, even though their forms and places in the organization structures continue to evolve.

Formulating and implementing strategy cannot be performed by one discipline alone, nor by staff or by individual line functions. But certainly business economists have important contributions to make. Indeed, articles in Business Economics over the years give ample testimony to the important kinds of contributions that practicing business economists have been making to major strategic decision processes in business firms. A brief sampling will illustrate. Filipello [1985] describes fundamental changes in the business environment in the chemical industry and the adaptation required by chemical companies. James [1987], discussing the airline industry, describes the role of business economics in planning and forecasting related to the critical decisions involved in the timing of new aircraft purchases. Matamoros [1987] describes the contributions to the Armstrong Company of Wilson Wright and Walter Hoadley during a period when "plastics technology and derivative product development were changing Armstrong's entire competitive environment. . ." [p. 54]

Thus business economists have long been performing important responsibilities in connection with strategic planning and related areas of long-and short-run forecasting. These experiences suggest that further interactions with the strategic planning processes are appropriate and feasible. Finally, some further aspects of implementation are treated.

IMPLEMENTING BROADER ROLES

FOR BUSINESS ECONOMISTS

The role of the business economist has been a continued area of analysis and discussion. Among the issues addressed are whether business economists should be staff or line and where they should be located in the organization structure. Those who propose business economics as a line function view business economics as a separate department with responsibility for a "bottom line" profit accountability. Others view "line" as executive positions in one or more of the functional areas, such as marketing or finance. With regard to place in the organization structure, the issues raised are whether business economics should be a staff function reporting to a top executive group or part of a line function such as finance, marketing, or production.

These are nonissues in the sense that generalizations about all companies are not possible. The roles of the business economist are a function of the industry, the company, its history, the background and personalities of top management, in relation to the particular skills and attributes of the business economist himself. With regard to the strategic planning processes, business economics will interact with other disciplines, because different backgrounds, different experiences, and different competences are required. This role has been stated clearly by Marina v.N. Whitman [1987].

"In formulating strategy, we ask, `What is there

about the economist's mindset that's maximally

useful in analyzing current conditions and providing

counsel to management?' There are several answers:

(1) the focus on tradeoffs, i.e., the `no free

lunch' mentality; (2) the concern with actual or

likely (as opposed to desired) consequences, with

results, not intentions. . . . (3) our ability to make

conditional predictions and to suggest ways in

which new information may be relevant to strategy."

[p. 54]

The key precept: Know the business - the industry, the firm, and its competitors. This precept implies monitoring all aspects of the environments of the organizations - international and domestic trends in economic, political and cultural developments. These represent the traditional areas of business economics in a broader perspective.

CONCLUSIONS

The nature of strategic planning suggest important interactive roles for business economists. But it should also be recognized that their training and experience enable business economists to make significant contributions in a wide range of areas important to the performance of organizations. The strategic planning process is one such area.

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McGraw-Hill, 1965. ________________, Implanting Strategic Management,

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International, 1984. Bogue, Marcus C., III, and Elwood S. Buffa, Corporate

Strategic Analysis, New York: The Free Press,

1986. Boston Consulting Group, The Strategy Development

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1984, pp. 70-94. Carroll, D.T., "A Disappointing Search for Excellence,"

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1983, pp. 78-88. Chung, Mary, and Alistair Davidson, "Business Experts,"

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(*)J. Fred Wesron is Cordner Professor of Money end Financial Markets at the Anderson Graduate School of Management, University of California, Los Angeles, CA., and an Associate Editor of this Journal. This paper benefited from suggestions by John Casson, Kwang Chung, Stan Ornstein and George Steiner.
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Date:Apr 1, 1989
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