Unit 4 · Topic 4.3 · about 30 minutes
Strategy and Decision Making
Explain how a strategy guides a business's tactics, then use the PACED model and return on investment to compare two options and recommend one.
Predict first
A bakery owner can grow in one of two ways. A food truck would cost $85,000 and add about $26,000 a year in profit. A second storefront would cost $210,000 and add about $48,000 a year. Which option earns more profit for each dollar she invests?
Strategy and tactics
A strategy is a plan or approach to achieving a goal. A business strategy describes how a business will achieve one or more goals, such as gaining a competitive advantage, fulfilling its mission, increasing revenues, reducing costs or increasing profits.
Businesses pursue different strategies because they have different capabilities, face different competitive landscapes and operate in different industries. Two grocery stores in the same town can chase the same shoppers in opposite ways. One competes on price, buying in bulk and keeping its selection small. The other competes on quality, with local produce and a full-service butcher counter, and charges more for it.
A strategy guides the business's decisions and the tactics it develops, which are the actions or approaches intended to advance the strategy. Say Harbor Pizza wants to grow its lunch sales, and its strategy is to become the fastest lunch option for people who work downtown. Online pre-ordering, a pickup shelf by the door and menus dropped off in office lobbies are all tactics. Each one is a specific action, and each one makes lunch faster or easier to get. An idea that does neither doesn't fit the strategy, however good it sounds.
| Business | Goal | Strategy | Two tactics |
|---|---|---|---|
| Harbor Pizza | Grow lunch sales | Be the fastest lunch option for downtown office workers | Online pre-ordering; a pickup shelf by the door |
| Elm Street Grocery | Increase profits | Compete on low prices by keeping costs down | Buy in bulk from fewer suppliers; carry fewer brands of each item |
| Bright Smile Dental | Gain a competitive advantage with busy families | Be the most convenient dentist in town for working parents | Evening and Saturday hours; back-to-back visits for siblings |
Why a clear strategy matters
A clearly defined strategy makes it easier to mobilize the business's resources and line them up behind one stated goal or challenge, and that makes success more likely. When Harbor Pizza's strategy is speed, the owner knows what to spend on first (a second oven before a dining-room remodel) and whom to hire (counter staff from 11 a.m. to 1 p.m.). Without that clarity, the kitchen and the marketing can pull in different directions.
Businesses typically identify, gather and track specific data to define a strategy, to evaluate how well it is working and to modify it. That data often covers the business's financial performance, its customers, its competitors and broader trends in its market. Harbor Pizza might track lunch orders per day, the average wait at the counter, what the sandwich shop next door charges and how many downtown offices have gone back to working in person. If fewer people work downtown, the strategy may need to change, however well the tactics were carried out.
The PACED model
Managers and individuals often use a deliberative process to make major decisions, instead of going with their gut. In this course it goes by the PACED model:
- Problem: define the problem to address or the decision to be made.
- Alternatives: develop the options.
- Criteria: establish the decision-making criteria, the measures you will compare the options on.
- Evaluation: evaluate each alternative against the criteria, using evidence.
- Decision: choose the best approach and support it.
Criteria include the key costs and benefits of each option. Some are quantifiable, such as the effect on production costs, total sales and profits. Others are intangible, such as the effect on the business's reputation, its mission and its core values. Leave the intangible ones out and you can pick an option that looks great on paper and quietly damages the brand.
Criteria typically include a financial consideration, often which option provides the greatest return on investment (ROI). ROI is the additional profit generated by an investment divided by the cost of the investment. Criteria can also include market, operational and organizational considerations.
| Consideration | The question it asks | For the food truck or the storefront |
|---|---|---|
| Financial | Which option provides the greatest return on investment? | The truck returns about 30.6% a year, the storefront about 22.9% |
| Market | How does each option affect the business's competitiveness? | A storefront across town would compete head-on with the bakery already there |
| Operational | How does each option affect supply chain risk? | A second store would double the flour orders from a supplier that already delivers late |
| Organizational | How does each option affect employees? | Bakers would have to split their time between two kitchens |
Worked exampleA decision worked through with PACED
Copper Kettle Coffee has lines out the door from 7 to 9 a.m., and some regulars have started buying their coffee across the street. The owner is weighing two options.
- Option A: a second espresso machine plus a third barista on weekday mornings. Setting it up costs $18,000.
- Option B: mobile ordering, so regulars can order ahead and skip the line. Setting it up costs $6,000.
She projects that Option A would add $5,400 a year in profit and Option B would add $2,400 a year. Work through the PACED model and make a recommendation.
Problem. Long morning lines are sending regulars to a rival. The decision is how to serve more customers between 7 and 9 a.m. without losing the ones the shop already has.
Alternatives. Option A adds equipment and staff. Option B adds mobile ordering. Changing nothing is also an option, but it leaves the problem in place.
Criteria. Return on investment, the effect on wait times for all customers, operational risk, and the effect on employees. Each one is a measure, not a verdict.
Evaluation. ROI for A is 5,400 divided by 18,000, which is 30%. ROI for B is 2,400 divided by 6,000, which is 40%, so B wins on ROI and costs far less. On wait times, A shortens the line for everyone, while B helps only the customers who use the app. On operational risk, B depends on an outside app service working every morning. On employees, A adds a job, while B piles pressure on the baristas whenever app orders stack up.
Decision. The problem is regulars leaving because of the wait, so the effect on wait times matters most here. Recommend Option A. Its 30% return is lower than B's 40% but still strong, and it fixes the problem for every customer. Say the trade-off out loud: the shop gives up 10 points of ROI to shorten the line.
Option A, chosen on wait times even though its ROI is lower. A recommendation for B could be just as good if it named its criteria, compared both options on each one, and supported the choice with evidence.
When the criteria disagree
Real decisions rarely line up neatly. The option with the best ROI may carry the most risk, or sit badly with the business's mission. Managers sometimes have to prioritize criteria that conflict, using data that is limited or imperfect, and so some decisions turn out to be wrong. Copper Kettle's profit projections are estimates, and nobody knows for sure how many regulars would use an app.
For major choices, managers also use strategic frameworks, which let a business systematically evaluate the internal and external variables of an option against its long-term goals and strategy. Porter's Five Forces and SWOT analysis, the subject of the next lesson, are two of them.
Check your understanding
A landscaping company buys a fleet of new mowers for $36,000. It expects the mowers to generate $8,100 in additional profit next year. What is the expected return on investment, as a percent?
A gym's strategy is to grow by attracting adults over 55 who have never belonged to a gym. Which of these is a tactic that advances that strategy?
A restaurant owner has listed two options for her slow Mondays: close on Mondays, or run a Monday family-meal deal. She then writes down that she will compare them on the change in profit, the effect on her staff's hours and the fit with the restaurant's family-friendly mission. Which step of the PACED model has she just completed?
A clothing company is deciding whether to move production from its own factory in Ohio to a cheaper contract factory overseas. Which criterion is an operational consideration?
Why does defining a clear strategy make a business more likely to reach its goal?
Course alignment, for teachers
AP Business with Personal Finance topic 4.3, Unit 4: Management and Strategy.